You are considering investing in Babua Corporation, which is expected to pay dividend of $10 a share at the end of the first year

What is estimated current stock price?

Answer: $500

Workings:

Formula for calculating estimated current stock price, under constant growth model is as follows;

Estimated current stock price = Next year dividend ÷ (Required rate of return – Growth rate)

Where,

Growth rate = 5% (Given in the question)

Required rate of return = 7% (given in question)

Next year dividend      = $10 (Expected dividend at the end of the 1^st year given in the question)

Fair value stock          = Next year dividend ÷ (Required rate of return – Growth rate)

                                    = $10 ÷ (0.07 – 0.05)

                                    = $10 ÷ 0.02

                                    = $500