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Gerald's Travel Service just paid $1.15 to its shareholders as the annual dividend....

Question:

Gerald's Travel Service just paid $1.15 to its shareholders as the annual dividend. Simultaneously, the company announced that future dividends will be increasing by 2.3%.

If you require a 13% rate of return, how much are you willing to pay to purchase one share of this stock?

Price of one share

Price of one share is computed using the dividend discount model. It gives the fair price or intrinsic value of the stock. At the price, the stock is traded in the market.

Answer and Explanation:

Given that Current Dividend, {eq}D_{0} {/eq} = $1.15, Growth rate, {eq}g {/eq} = 2.3% and Required return, {eq}k {/eq} = 13%

One share of the stock purchased, {eq}P_{0} {/eq} using constant growth model, we get

{eq}P_{0} = \frac{D_{0}(1+g)}{k - g} {/eq}

{eq}P_{0} = \fracNo variable 1.15(1.023) defined.{0.13 - 0.023} {/eq}

{eq}P_{0} {/eq} = $10.99

Hence, the one share of the stock purchased is $10.99.


Learn more about this topic:

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The Dividend Growth Model

from Finance 101: Principles of Finance

Chapter 14 / Lesson 3
10K

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