Question

7) What is the estimated current price of a share of ABC Company stock based on the Dividend Discount Model? The annual required rate of return is 11.3%. ABC just paid their annual dividend of $1.63 a share and the expected growth rate of the dividend is 4.4% per year. Answer to the nearest penny.

8) Use the Dividend Discount Model to compute the expected price of a stock in 2 years. Each share is expected to pay a dividend of $2.37 in one year. Investors' annual required rate of return is 9.6%, and the expected growth rate of the dividend is 5.4% per annum. Answer to the nearest penny.

Answer 1

(1) -
As per dividend discount formula, price of stock can be determined by using firm's Expected dividend per share (D1),
cost of equity (ke) and growth rate (g)
Dividend just paid (d0) =					1.63
Dividend expected to be paid next year (D1) =					1.70172
1.63 + (1.63 *4.4%) =
Required rate of return (ke) =				11.3% or	0.113
Growth rate (g) =				4.4% or	0.044
As per Dividend discount formula
Value of Stock (P0) =          D1/ (ke-g)
		1.70172	/(0.113 - 0.044)
		24.66261
So, estimated current price of share is $24.66.
(2) -
Dividend in one year (d1) =					2.37
Dividend in two year (D2) = (2.37 + (2.37*5.4%))					2.49798
Dividend in three years (d3) = (2.49798 +(2.49798 + 5.4%)=					2.632871
Required rate of return (ke) =				9.6% or	0.096
Growth rate (g) =				5.4% or	0.054
As per Dividend discount formula
Value of Stock (P2) =          D3/ (ke-g)
		2.632871	/(0.096 - 0.054)
		62.6874
So, expected share price in year 2 is $62.69.