A stock is expected to pay a dividend of $0.75 at the end of the year. The required rate of return is rs = 10.5%, and the expected constant growth rate is g = 3.5%. What is the stock's current price?
Select the correct answer.
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Solution:
As per the Gordon growth model the current price of a stock can be calculated using the following formula :
P0 = D1 / (rs – g )
Where,
P0 = Current Price of the stock
D1 = Dividend payment at the end of the year
rs = required rate of return
g = Expected constant growth rate
As per the information given in the question we have
D1 = $ 0.75 ; g = 3.5 % = 0.035 ; rs = 10.5 % = 0.105
P0 = To find
Applying the above information in the formula we have
= 0.75 / ( 0.105 – 0.035 )
= 0.75 / 0.07
= 10.7143
= $ 10.71 ( when rounded off to two decimal places )
Thus the stock’s current price = $ 10.71
The solution is option b. $ 10.71
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