Papa Pizza just paid $0.65 to its shareholders as the annual dividend. Simultaneously, the...

Question:

Papa Pizza just paid $0.65 to its shareholders as the annual dividend. Simultaneously, the company announced that future dividends will be increasing by 0.75%.

If you require a 11.8% rate of return, how much are you willing to pay to purchase one share of this stock?

Annual Dividend

In gordon model, the dividend increases constantly forever. It consider the infinite dividend series and discount it back at the required rate of return. This model assumes the companies are permanent.

Answer and Explanation:

Given that Current Dividend, {eq}D_{0} {/eq} = $0.65, Growth rate, {eq}g {/eq} = 0.75% and Required return, {eq}k {/eq} = 11.8%

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

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

{eq}\displaystyle P_{0} = \frac{0.65(1.0075)}{0.118 - 0.0075} {/eq}

{eq}P_{0} {/eq} = $5.93

Hence, the one share of the stock purchased is $5.93.


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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