2. Constant growth and zero growth dividend valuation model AaAa Urban Drapers I

Question

2. Constant growth and zero growth dividend valuation model AaAa Urban Drapers Inc., a drapery company, has been successfully doing business for the past 15 years. It went public eight years ago and has been paying out a constant dividend of $4.48 per share every year to its shareholders. In its most recent annual report, the company informed investors that it expects to maintain its constant dividend in the foreseeable future and that dividends are not expected to increase. If you are an investor who requires a 24.00% rate of return and you expect dividends to remain constant forever, then your expected valuation for Urban Drapers stock today is -per share. Urban Drapers has a sister company named Super Carpeting Inc. (SCI). SCI just paid a dividend (Do) of $3.36 per share, and its annual dividend is expected to grow at a constant rate (g) of 7.00% per year, if the required return (ka) on SCI's stock is 17.50%, then the expected stock price of SCI's shares is per share. Which of the following statements is true about the constant growth model? O The constant growth model can be used if a stock's expected constant growth rate is more than its required return. O The constant growth model can be used if a stock's expected constant growth rate is less than its required return. Use the constant growth model to calculate the appropriate values to complete the following statements about Super Carpeting Inc.: If SCI's stock is in equilibrium (that is, where the expected stock price is equal to the market value of the stock), the current expected dividend yield on the stock will be . SCI's expected stock price one year from today will be per share. Grade It Now Save & Continue Continue without savin

Explanation / Answer

1

P0=D1/(r-g)

here, r=24%

g=0

D1=4.48

So, Price, P0=4.48/0.24=$18.667

2

Price=3.36*1.07/(0.175-0.07)=$34.24

3

Option B

As per equation Price=D1/(r-g), if g or growth rate is more than r or required return, then Price would be negative, which is not possible. Hence, we use Dividend Discount Model only when growth rate is less than the required return.

4

Current Dividend Yield=D1/P0=3.36*1.07/34.24=10.5%

Or, Current Dividend Yield=r-g=17.5-7=10.5%

5

Price one year from today, P1=D2/(r-g)=3.36*1.07*1.07/(0.175-0.07)=$36.6368

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