Question

Holtzman Clothiers's stock currently sells for $40 a share. It just paid a dividend of $3.5 a share (i.e., D0 = $3.5). The dividend is expected to grow at a constant rate of 4% a year.

a. What stock price is expected 1 year from now?

b. What is the required rate of return?

Answer 1

It can be calculated with help of constant dividend growth model. Based on this current stock price can be calculated with help of below formula-

where, Po is the current market price.
D0= Dividend just paid by company.
g = Growth rate
Ke = cost of equity

Here,

Po = $ 40

D0 = 3.5 $

g = 4 %

40 ( Ke - 0.04 ) = 3.64

40Ke - 1.6 = 3.64

40Ke = 3.64 + 1.6

40Ke = 5.24

Ke = 5.24 / 40

= 0.131

Required rate of return = 13.1 %

Stock price expected one year from now can be calculated as-

D1 = D0(1+g)

D0 = 3.5 $

D1 = 3.5 ( 1 + 0.04)

D1 = 3.64 $

= 41.6

P1 = $ 41.6

Stock price is expected 1 year from now = $ 41.6

Required rate of return = 13.1 %