The Fish House increases its dividend each year. The next annual dividend is expected to be $0.85 a share. Future dividends will increase by 6% annually.
What is the current value of this stock if the discount rate is 15%?
Dividend Growth Model
It is the valuation model that determines the fair value of the stock price assuming the stock price to be equal to the present value of the future cash flows expected to be received from the stock in the form of dividends, discounted using the rate (r - g). The underlying assumption is that the growth rate at which the dividends are expected to grow or decline remains constant to perpetuity.
Answer and Explanation:
The current value of Fish House's stock is $9.44.
As per the data:
- Next dividend, D1 = $0.85
- Constant growth rate, g = 6%
- Required return, r = 15%
- Current stock price, P0 =?
The current stock price can be determined using DDM:
- P0 = D1 / (r - g)
- P0 = $0.85 / (15% - 6%)
- P0 = $9.44
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from Finance 101: Principles of FinanceChapter 14 / Lesson 3