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Shares of the Katydid Co. common stock are currently selling for $33.60. The last dividend paid...

Question:

Shares of the Katydid Co. common stock are currently selling for $33.60. The last dividend paid was $1.60 per share. The market rate of return is 10%. At what rate is the dividend growing? Assume the market is in equilibrium.

Dividend Discount Model:

This problem entails utilization of the constant growth dividend discount model, which is also known as the Gordon Growth Model. It is a popular stock valuation model which views the fair value of a stock as the sum of all future dividends, discounted to the present, using an appropriate rate.

Answer and Explanation:

The answer is 5.0%.

Explanation:

The formula for the DDM is provided below.

P0 = D1 / (r - g)

where,

  • P0 = intrinsic value of stock
  • D1 = dividend payment one year from today
  • r = discount rate
  • g = growth rate

To solve for g, we must be cognizant of the fact that D1 = D0(1 + g), where D0 is the last dividend paid.

Armed with this awareness, we can structure and solve the problem, using known information, as follows:

$33.60 = $1.60(1 + g) / (0.10 - g) $3.36 - $33.60g = $1.60 + $1.60g $1.76 = $35.2g

g = 0.05 or 5.0%


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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