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The Starr Co. just paid a dividend of $2.10 per share on its stock. The dividends are expected to...

Question:

The Starr Co. just paid a dividend of $2.10 per share on its stock. The dividends are expected to grow at a constant rate of 5% per year, indefinitely. Investors require a return of 14 percent on the stock. What is the current price?

Valuation of Stock:

The current price of the stock of the company that the investor is ready to pay can be calculated by applying various financial models. One of them is the dividend growth model in which, the dividend payout amount and its growth rate is provided, and the expected required rate of return is given

Answer and Explanation:

The current price of the stock will be calculated by using the dividend discount model

  • The dividend paid this year is $2.10
  • The expected Dividend growth rate is 5%
  • The dividend to be paid next year is $2.205 ($2.10 x 105%)
  • The required rate of return of 14.00%

The formula for dividend growth model will be used to calculate the stock price today

{eq}S_p= D_1 / (R_m - G) {/eq}

Where

  • {eq}S_p {/eq} = stock price as on today
  • {eq}D_1 {/eq} = dividend to be paid next year
  • {eq}R_m {/eq} = required rate of return
  • G = growth rate of the dividends

Substituting the numbers in the formula, we get

{eq}S_p {/eq} = 2.205 / (0.14 - 0.05)

{eq}S_p {/eq} = 2.205 / 0.09

{eq}S_p {/eq} = $24.50

The current price of the stock is $24.50


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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