You have a stock that you are holding for one year. It has an estimated dividend payout of $2.50 and an expected sale price of $43. Using the dividend discount model, calculate the value of the stock if your required rate of return is 12%.
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A. B. C. D.Explanation
Calculation = $2.50/(1+.12) + $43.00/(1+.12) = $40.63.
To calculate the value of the stock using the dividend discount model (DDM), you need to consider the present value of the expected dividends and the present value of the expected sale price at the end of the holding period.
The formula for the DDM is as follows:
Stock Value = Present Value of Dividends + Present Value of Sale Price
To calculate the present value of dividends, divide the expected dividend payout by (1 + required rate of return) raised to the power of the holding period. Since the holding period is one year, the formula becomes:
Present Value of Dividends = Dividend / (1 + Required Rate of Return)^Holding Period
Present Value of Dividends = $2.50 / (1 + 0.12)^1 Present Value of Dividends = $2.50 / (1.12) Present Value of Dividends = $2.23
To calculate the present value of the sale price, divide the expected sale price by (1 + required rate of return) raised to the power of the holding period:
Present Value of Sale Price = Sale Price / (1 + Required Rate of Return)^Holding Period
Present Value of Sale Price = $43 / (1 + 0.12)^1 Present Value of Sale Price = $43 / (1.12) Present Value of Sale Price = $38.39
Stock Value = Present Value of Dividends + Present Value of Sale Price
Stock Value = $2.23 + $38.39 Stock Value = $40.62 (rounded to the nearest cent)
Based on the calculations, the value of the stock, using the dividend discount model, is approximately $40.62. However, none of the provided answer choices exactly matches this result.