Problem 5. The dividend growth model is used by many investors to value stock. U
ID: 2713377 • Letter: P
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