Question

Railway Cabooses just paid its annual dividend of $4.70 per share. The company has been reducing the dividends by 12.8 percent each year. How much are you willing to pay today to purchase stock in this company if your required rate of return is 15 percent?

Answer 1

Answer:

The maximum that should be paid for the stock today is $14.74

Explanation:

To calculate the price of the stock today, we can use the constant growth model of DDM. The DDM values a stock based on the present value of the expected future dividends from the stock. The formula for price today under the constant growth model of DDM is,

P0 = D0 * (1+g)  /  (r - g)

Where,

• D0 is the dividend today
• g is the constant growth rate
• r is the required rate of return

As the growth rate in this case is negative, so we will enter the negative g.

P0  =  4.7 * (1 - 0.128) / (0.15 + 0.128)

P0 = $14.74244604 rounded off to $14.74