Problem 5. The dividend growth model is used by many investors to value stock. U

Question

Problem 5. The dividend growth model is used by many investors to value stock. Using thedividend-payout ratio, and the sustainable growth rate equation in the dividend growth model,calculate the price of a share of stock today, using the following dividend growth modelequation. Then use your results to explain whether the firm should pay a dividend or expand itsmanufacturing capability.

The dividend-payout ratio is one minus b, where b is the retention ratio; the dividend nextyear will be the earnings next year, E1, times one, minus the retention ratio: P0 = E1(1–b). The sustainable growth rate is the return on equity times the retention ratio: Rs – ROE x b.The dividend growth model equation for calculating the price of a share of stock today is:

P0 = E1(1–b) / Rs – ROE x b

Explanation / Answer

The only way to cancel is by ignoring. Please ignore.

Price can be calculated using the formula as below

Price = Dividend / (K-g)

Here Dividend should be next year dividend, K is required rate of return and g is growth rate

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