You believe that the Non-stick Gum Factory will pay a dividend of $4 on its comm

Question

You believe that the Non-stick Gum Factory will pay a dividend of $4 on its common stock next year. Thereafter, you expect dividends to grow at a rate of 2% a year in perpetuity. If you require a return of 15% on your investment, how much should you be prepared to pay for the stock? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

You believe that the Non-stick Gum Factory will pay a dividend of $4 on its common stock next year. Thereafter, you expect dividends to grow at a rate of 2% a year in perpetuity. If you require a return of 15% on your investment, how much should you be prepared to pay for the stock? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Explanation / Answer

We need to use the Gordon's constant dividend growth model to calculate the stock price today. The formula for calculating stock price under this method is,

Stock Price (P0) = D1/(ke - g) where D1 is the dividend next year, ke is the required rate of return and g is the growth rate.

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Solution:

Here, D1 = $4, ke = 15% and g = 2%.

Using these values in the above formula, we get,

Stock Price (P0) = 4/(15% - 2%) = $30.77

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