Railway Cabooses just paid its annual dividend of $3.70 per share. The company h

Question

Railway Cabooses just paid its annual dividend of $3.70 per share. The company has been reducing the dividends by 12.3 percent each year. How much are you willing to pay today to purchase stock in this company if your required rate of return is 14 percent?

Railway Cabooses just paid its annual dividend of $3.70 per share. The company has been reducing the dividends by 12.3 percent each year. How much are you willing to pay today to purchase stock in this company if your required rate of return is 14 percent?

Explanation / Answer

Let P=stock's current Price= ?

D0=just paid dividend= 3.70

g=dividend growth rate per year=-12.3%=-.123

let r=expected rate of return=14%=.14

According to constant growth model,

P=D0*(1+g)/(r-g)

pu values=>P=3.70 *(1-.123)/(.14-(-.123))

=>P=3.70 *(0.877)/(.14+.123)=3.70 *(0.877)/0.263

=>P=12.34

Thus $12.34 you should be willing to pay today to purchase stock in this company if your required rate of return is 14 percent.

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