Question

Assume that you are using the dividend discount model (the Gordon Growth Model) to value stock. The stock currently pays no dividends, but expected to begin paying dividends in five years. The firm's cost of equity is 11%. Compute the value of a stock paying no dividends today, but that is expected to pay annual dividends of $4 in five years and the stock is expected to grow at a rate of 9% for the next six years that it started paying dividends, then slows to a long-term growth rate of 4.5%. How much is that stock worth today?

Group of answer choices

$45-$50                                                           
                                                                                   

$40-$45

$50-$55

> $55

< $40

Answer 1

Solution

11.00%
Cash flows	Year	Discounted CF
-	0	0.00
4.00	1	3.60
4.36	2	3.54
4.75	3	3.47
5.18	4	3.41
5.65	5	3.35
6.15	6	3.29
6.71	7	3.23
107.85	7	51.95

Based on above, value in 4 years = 75.85

value today = 75.85/1.11^4 = 49.96

A) $45-$50