You have a stock that you are holding for one year. It has an estimated dividend payout of $1.10 and an expected sale price of $22. Using the dividend discount model, calculate the value of the stock if your required rate of return is 14%.
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A. B. C. D.Explanation
Bring both dividend and expected sale price to present value and sum the two: V = $1.10/1.14 + $22.00/1.14 = $20.26
To calculate the value of the stock using the dividend discount model, we need to discount the expected future cash flows (dividends and sale price) back to the present value using the required rate of return.
The dividend discount model (DDM) formula is: Value of Stock = Dividend / (1 + Required Rate of Return) + Sale Price / (1 + Required Rate of Return)
Given:
Let's substitute these values into the formula:
Value of Stock = $1.10 / (1 + 0.14) + $22 / (1 + 0.14)
Calculating the values within the parentheses: Value of Stock = $1.10 / 1.14 + $22 / 1.14
Simplifying: Value of Stock = $0.964 + $19.298
Value of Stock = $20.262
Therefore, the value of the stock, when using the dividend discount model with a required rate of return of 14%, is approximately $20.26.
The correct answer is B. $20.26.