Question

You are the financial manager of Any Brother company. One day, the CEO of the company comes to your office and asks you the following questions: “ What determine the stock price? Is it dividend? What else should we consider? I notice that there are some companies like Tencent, that pays very small amount of dividend per share to shareholders could have very good rise in their stock price. Does it mean that we should pay less or even no dividend to shareholders?” “Besides, our company has become a publicly listed firm in Hong Kong for three years. Should the company still concern its current stock price? Why?”, said the CEO. Regarding the questions of the CEO, explain your points to CEO. Illustrate your explanation with example(s). (limit your answer to 450 words).

Answer 1

Solution:

When we are talking about the determination of the stock price there are various models which can be used or come into the picture and dividend is not the only parameter that determines the stock price.

Lets consider a very popular model known as the Gordon's Constant growth model.

As per the Gordon's Model , Value of the stock = D1 / (R - g)

Where D1 -> Next Year's dividend

R -> required return .

g - > growth rate of the company.

So its the required return , the company's growth as well as the dividend together which determines the stock price.

Example:

D1 = 5 , R = 16% , g = 6%

Stock Price = 5 / (.16 - .06) = 5 / .1 = 50

Now the stock price will vary depending on the above mentioned three parameters.