What is the value of a share of common stock that paid $2.00 last year, the growth rate is 8%, assume the risk free rate is 4%, the market return is 10% and the Beta is 1.5.
To calculate the value of a share of common stock using the dividend discount model (DDM), you need to consider the dividend payment, growth rate, risk-free rate, market return, and Beta.
The DDM formula is as follows:
Stock Value = Dividend Payment / (Discount Rate - Growth Rate)
1. First, calculate the discount rate using the Capital Asset Pricing Model (CAPM) formula:
Discount Rate = Risk-Free Rate + Beta * (Market Return - Risk-Free Rate)
Given:
- Dividend Payment = $2.00
- Growth Rate = 8%
- Risk-Free Rate = 4%
- Market Return = 10%
- Beta = 1.5
Calculating the discount rate:
Discount Rate = 4% + 1.5 * (10% - 4%)
Discount Rate = 4% + 1.5 * 6%
Discount Rate = 4% + 9%
Discount Rate = 13%
2. Now, you can calculate the stock value using the DDM formula:
Stock Value = $2.00 / (13% - 8%)
Stock Value = $2.00 / 5%
Stock Value = $40.00
Therefore, the value of a share of common stock is $40.00.