ABC Inc will pay a dividend of 245 next year Assume that the

ABC Inc. will pay a dividend of $2.45 next year. Assume that the company will maintain a constant growth rate of 6% a year forever. If you want a 9% rate of return, how much will you pay for the stock? You observe a stock price of S18.75. You expect a dividend growth rate of 5% and the most recent dividend was $1.50 What is the required return?

Solution

a. Current Value of stock $ 81.67 Working: As per Capital Asset Pricing method, Current Value of stock = D1/(Ke-g) Where, = 2.45/(9%-6%) D1 Dividend of next year $       2.45 = $    81.67 Ke Required rate of return 9% g Growth rate 6% b. Required return 13.40% Working: As per Capital Asset Pricing method, Required return = (D0*(1+g)/P0)+g Where, = (1.50*(1+0.05)/18.75)+0.05 D0 $       1.50 = 13.40% g 5% P0 $    18.75