The common stock of Blooth, Incorporated currently pays a $0.35 per share dividend, and this dividend is anticipated to grow 13% annually. Assuming that investors require a 16% per year rate of return on their investment, what is the value of this common stock?
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A. B. C. D. E. F.B
To determine the value of this common stock using the Infinite Period Dividend Discount Model, the following equation is used:
{P0 = [D1 / (k - g)]}
Where: P0 = the price of the common stock at t0, D1 = the annual dividend at t1 (this is found by multiplying the dividend at t0 by (1 + expected growth rate), k = the required rate of return, And g = the anticipated growth rate.
In this equation, all of the necessary information has been provided, and the calculation of the price of this common stock is as follows:
{P0 = [(0.35 * 1.13) / (0.16 - 0.13)] = $13.18.
While the Infinite Period DDM is a useful tool, it frequently inappropriate for valuation purposes because of its generous assumptions. Specifically, the Infinite
Period DDM assumes that dividends will grow at a steady rate indefinitely, and that this rate is both known and measurable. For most common stocks, the use of the Infinite Period DDM will produce a measure of value that is skewed from objective reality.
Nonetheless, this valuation model is frequently cited and represents a powerful tool within specified parameters.