Question

Consider a stock that currently pays a dividend of $0.85 a share. You have a required return on equities of 10%.

a) If you expect the dividend to grow at a rate of 4% a year, what price would you place on the stock using the Gordon grown model?

b) You are considering just holding the stock for one year. If you think the dividend next year will be 4% larger than the current dividend and the price next year will be $15.00, what price would you place on the stock?

c) If you buy the stock now for $14.25, you collect the dividend payment next year that is 4% larger, and you then sell the stock for $15.85, what is your rate of return for the year?

Answer 1

In the given Ques, in a part we assumed the divided received is at the end of year that is D1. Also about Gordon growth model =E(1-b) /ke -br.

Earning is a combination of dividend and retained earnings.

In part b as we retain that for one year D1 of first year become our D0. It becomes current than expected. And we have calculated this by simple formula of Modigliani approach for dividend.

In the third part we said we will get 4% higher dividend in future which is D1 and future price at which we are going to sold is our p1. So here also Modigliani approached is used. Which is also called dividend irrelevant theorem. ke =17.43 % in last part which is calculated with help of Modigliani-miller approach.