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On January 1, 20X1, International Copy Machines (ICOM), one of the favorites of the stock market, was priced at $500 per share
On January 1, 20X1, International Copy Machines (ICOM), one of the favorites of the stock market, was priced at $500 per share. This price was based on an expected dividend at the end of the year of $5 per share and an expected annual growth rate in dividends of 15 percent into the future. By January 20X2, economic indicators have turned down, and investors have revised their estimate for future dividend growth of ICOM downward to 9 percent. What should be the price of the firm's common stock in January 20X2? Assume the following: 1. A constant dividend growth valuation model is a reasonable representation of the way the market values ICOM. (3) 2. The expected dividend at the end of 20X2 is $6.45 share.
Expert Solution
Current Price P0= D1/(r-g). Therefore, r= (D1/P0)+g
Where P0= Current price, r= Rate of return, g= growth rate of dividend and D1= First year dividend.
On 1 January 20X1,
Given, Next Dividend= $5, Price P0= $500 and growth rate g= 15%
Therefore, required rate of return r= (5/500)+0.15 = 16%
On 1 January 20X1,
Also given, in Jan 20X2,
Next dividend = $6.45 and Growth rate g= 9%
Therefore, price P in January 20X2= 6.45/(16%-9%) = $92.14
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