1. Royal Bank common shares pay dividends annually. They just paid a $1.50 divid
ID: 2383215 • Letter: 1
Question
1. Royal Bank common shares pay dividends annually. They just paid a $1.50 dividend. Stock holders require a return of 12%. Royal is expected to continue paying dividends that will grow at 3.5% per annum in perpetuity. What is the fair price of a share of Royal Bank Stock?
2. If the price of Hanbags Inc. stock is $43, its required return is 20% and the last dividend paid was $3, what is its dividend growth rate?
3. Universal's preferred shares pay a 6.5% annual dividend on a $50 - par value. The next dividend is due in one year. The required return of preferred shareholders is 9%. What is the fair price for the preferred shares?
Explanation / Answer
Dividend growth model connects the value of a firm’s equity and its market cost of equity, by exhibiting the expected future dividends receivable by the shareholders as a constantly growing perpetuity.
It can be computed using the following formulae:
P0 = D1 / ( Ke - g )
Where:
P0 = ex-dividend equity value today.
D1 = expected future dividend at Time 1 period later.
Ke = cost of equity per period.
g = constant periodic rate of growth in dividend from Time 1 to infinity.
Substituting the values in the formulae:
P0 = D1 / ( Ke - g )
=1.5+(1.5*3.5%)/(12%-3.5%)
=1.5525/8.5%
=$18.26
Hence, the fair value of the royal stock is $18.26.
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.