You are interested in investing in a company that expects to grow steadily at an annual rate of 6 percent for the foreseeable future. The firm paid a dividend of $2.30 last year. If your required rate of return is 10 percent, what is the most you would be willing to pay for this stock? (Round to the nearest dollar.)

Question

Anya Robbins

Business

10 September, 12:08

You are interested in investing in a company that expects to grow steadily at an annual rate of 6 percent for the foreseeable future. The firm paid a dividend of $2.30 last year. If your required rate of return is 10 percent, what is the most you would be willing to pay for this stock? (Round to the nearest dollar.)

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Answers (1)

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Armani Petersen · Answer 1

The fair value of the stock under constant growth model is $60.95. This is the most that should be paid for the stock today.

Explanation:

The price of the stock for a company having constant dividend growth can be calculated using the constant growth model of DDM. The formula for the constant growth model is:

P0 or price today = D0 * (1+g) / r - g

Where,

D0 * (1+g) is the dividend expected for the next period or D1. r is the required rate of return g is the growth rate in dividends

P0 = 2.3 * (1+0.06) / (0.1 - 0.06)

P0 = $60.95