Question

A company's stock is expected to pay a dividend of $3 at the end of the year. If investors require a 7.5% return, and dividends grow at a constant 3.5%, what price should the stock be selling four years from today?

Answer 1

Answer:

Price at the end of year 4 shall be $86

Explanation:

Using dividend growth model we know that

P0 = D1/(Ke - g)

P0 = Current market price

D1 = Dividend at the end of the year

Ke = Expected return

g = Expected growth

Four years from today shall mean P4

for that we need D5

D5 = ((((D1 + g) + g) + g) + g)

$=((((3 + 3\times0.035) \times 1.035) \times 1.035) \times 1.035)\\= 3.44$

P4 = 3.44/(0.075-0.035)

= 3.44/0.04

= $86