TechSvx earned $5.00 per share and paid a $4.00 dividend per share last year, and is...

TechSvx earned $5.00 per share and paid a $4.00 dividend per share last year, and is expected to continue to pay out 80% of its earnings as dividends for the foreseeable future. The firm is expected to generate a 14% return on equity in the future, and you require a 15% return on the stock.

a. What should be the value of the stock today (according to the constant growth rate dividend discount model)?

b. What should be the value of the stock one year from today? Is it higher or lower than today’s price? Explain why this is the pattern, intuitively.

Solutions

Expert Solution

value of the stock( Today)

Growth rate = ROE*Retention Ratio

Growth rate = 14%*(1-80%)

Growth rate = 2.8%

value of the stock = Expected Dividend(Next year)/(Expected Required Return - Growth rate

value of the stock( Today) = 4*(1+2.80%)/(13%-2.80%)

=4.112/10.20%

value of the stock = $ 40.31 Per Shares

value of the stock one year from today

value of the stock = Expected Dividend( year 2)/(Expected Required Return - Growth rate)

Expected Dividend(Year 2)

=4*(1+2.80%)(1+2.80%)

=$4.227

value of the stock = 4.227/(13%-2.80%)

=4.227/10.20%

value of the stock one year from today = $ 44.44 Per Shares

it is higher than today’s price

ekkarill92 answered 1 year ago

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