A stock is expected to pay a dividend of $0.75 at the end of the year.
The required rate of return is 12.5%, and the expected constant growth rate is 8.5%.
What is its current price?
To determine the current price of the stock, we need to use the Gordon Growth Model, also known as the Dividend Discount Model (DDM).
The Gordon Growth Model formula is: P = D / (r - g)
Where:
P = Current price of the stock
D = Dividend expected to be paid at the end of the year ($0.75)
r = Required rate of return (12.5%, or 0.125 as a decimal)
g = Expected constant growth rate (8.5%, or 0.085 as a decimal)
Plugging in the values into the formula:
P = 0.75 / (0.125 - 0.085)
P = 0.75 / 0.04
P = 18.75
Therefore, the current price of the stock is $18.75.