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Homework answers / question archive / A common stock just paid 50 dirhams as dividend per shareThis dividend is expected to grow by 5until Infinity

A common stock just paid 50 dirhams as dividend per shareThis dividend is expected to grow by 5until Infinity

Finance

A common stock just paid 50 dirhams as dividend per shareThis dividend is expected to grow by 5until Infinity. The required rate of return is 15. Respond to the following a. Determine the value of this common stock b. The market price of this stock is currently 500 dirhams per share. What should be the position of an investor in this case fue buy or sel? Motivate your answer c.You can purchase one share of Surter Company common stock for today. You expect the price of the common stock to increase to 585 per share in one year. The company paysan annual dividend of $3.00 per share. What is your expected rate of return for Sumterstock 

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Answer (a):

Calculation of value of common stock with dividend growth model :

As per dividend growth model, P0 = D0 (1+g) / (ke -g)

D0 = 50

g = 5%

ke = 15%

Therefore P0 = 50 (1+0.05) / (0.15-0.05)

= 52.5 / 0.10

= 525

Therefore value of common stock = 525 dirhams

Answer (b) :

As we have calculated in answer (a) that value of stock is 525 but market price of this stock is 500 dirhams. Therefore stock is undervalued and investor should buy the stock.

Answer (c):

P0 given = $80

D1 = $3

g = (85-80) / 80 = 6.25%

As per dividend growth model, P0 = D1 / (ke -g)

80 = 3 / (ke - 0.0625)

(ke - 0.0625) = 0.0375

ke = 0.0375 + 0.0625

ke = 0.10 or 10%

Therefore expected rate of return = 10%

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