The Lo Company earned $ 2.60 per share and paid a dividend of $ 1.30 per share in the year just ended. Earnings and dividends per share are expected to grow at a rate of 5 percent per year in the future. Determine the value of the stock:
A. if the required rate of return is 12 percent.
B. if the required rate of return is 15 percent.
C. Given your answers to (a) and (b), how are stock prices affected by changes
Why did you post the name of a school instead of the school subject?
accident!
To determine the value of the stock, we can use the Gordon Growth Model, also known as the Dividend Discount Model (DDM). The formula for the DDM is as follows:
Stock Value = Dividends per share / (Required Rate of Return - Dividend Growth Rate)
Let's calculate the value of the stock in each scenario:
A. If the required rate of return is 12 percent:
Dividends per share = $1.30
Dividend Growth Rate = 5% = 0.05
Required Rate of Return = 12% = 0.12
Stock Value = $1.30 / (0.12 - 0.05) = $1.30 / 0.07 = $18.57
Therefore, the value of the stock is $18.57 if the required rate of return is 12%.
B. If the required rate of return is 15 percent:
Dividends per share = $1.30
Dividend Growth Rate = 5% = 0.05
Required Rate of Return = 15% = 0.15
Stock Value = $1.30 / (0.15 - 0.05) = $1.30 / 0.10 = $13.00
Therefore, the value of the stock is $13.00 if the required rate of return is 15%.
C. Stock prices are affected by changes in the required rate of return. As the required rate of return increases, the stock price decreases. Conversely, if the required rate of return decreases, the stock price increases. This is because the required rate of return reflects the investor's expectations and perceived risk associated with the investment. Higher required rates of return indicate higher risk and, therefore, lower stock prices. Conversely, lower required rates of return indicate lower risk and higher stock prices.