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16 October, 14:29

GHI Co. is planning to pay a dividend of $3.20 in the next year and expects to grow the dividend at a constant rate of 4% per year, indefinitely. If the required rate of return buy shareholders is 12%, then the price the price of this stock should be:

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  1. 16 October, 14:38
    The price of this stock = $41.6



    The Dividend Valuation Model is a technique used to value the worth of an asset. According to this model, the worth of an asset is the sum of the present values of its future cash flows discounted at the required rate of return.

    So if an asset (e. g a stock) promises some cash flows in the future, those cash flows need to be brought to their present values and then be added to arrive at the value of the asset.

    This model is based on the concept of the time of money. The idea that $1 today is not the same as $1 tommorow. The $1 of today is worth more than that of tomorrow; and because of the opportunity to earn interest. So to determine the worth of a future cash flow, we compute its worth today - its present value.

    The Present Value of a future cash flow is the amount that needs to be invested today at a particular rate of return to equal the same cash flow in the future. Present value means the value in year 0 or now

    The process of calculating the present value of a future sum is called discounting. So to calculate the stock price in this question, we shall discount the future dividends using the required rate of return and then add them together.

    Applying this model, the price of the stock

    P = D (1+g) / (r-g)

    D in year 0 (i. e now), r = required rate of return, g - growth rate

    D - 3.20, r - 0.12, g - 0.04

    P = (3.20 * (1+0.04)) / (0.12-0.04)

    P = $41.6

    The price of the stock = $41.6
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