MMK Cos. normally pays an annual dividend. The last such dividend paid was $2.3, all future dividends are expect to grow at a rate of 6 percent per year, and the firm faces a required rate of return on equity of 18 percent. If the firm just announced that the next dividend will be an extraordinary dividend of $29.0 per share that is not expected to affect any other future dividends. What should the stock price be?
To calculate the stock price, we can use the dividend discount model (DDM). DDM assumes that the value of a stock is equal to the present value of all its future dividends.
First, let's calculate the value of the ordinary dividends using the constant growth formula. The formula for the present value of constant growth dividends is:
Po = D / (k - g)
Where:
Po = stock price
D = last dividend paid
k = required rate of return on equity
g = growth rate of dividends
Given:
Last dividend paid (D) = $2.3
Growth rate of dividends (g) = 6%
Required rate of return on equity (k) = 18%
Using the formula:
Po = $2.3 / (0.18 - 0.06) = $2.3 / 0.12 = $19.17
So, the stock price based on the ordinary dividends is $19.17.
Next, let's calculate the stock price considering the extraordinary dividend. Since the extraordinary dividend is not expected to affect any other future dividends, we can simply add it to the stock price based on the ordinary dividends:
Stock price = $19.17 + $29.0 = $48.17
Therefore, the stock price, considering the extraordinary dividend, should be $48.17.