In: Finance
Quantitative Problem 1: Hubbard Industries just
paid a common dividend, D0, of $1.90. It expects to grow
at a constant rate of 4% per year. If investors require a 8% return
on equity, what is the current price of Hubbard's common stock? Do
not round intermediate calculations. Round your answer to the
nearest cent.
$ per share
Zero Growth Stocks:
The constant growth model is sufficiently general to handle the case of a zero growth stock, where the dividend is expected to remain constant over time. In this situation, the equation is:
Note that this is the same equation developed in Chapter 5 to value a perpetuity, and it is the same equation used to value a perpetual preferred stock that entitles its owners to regular, fixed dividend payments in perpetuity. The valuation equation is simply the current dividend divided by the required rate of return.
The price is computed as follows:
= [ Dividend just paid x (1 + growth rate) ] / (return on equity - growth rate)
= [ $ 1.90 x 1.04 ] / (0.08 - 0.04)
= $ 1.976 / 0.04
= $ 49.40