Given current earnings of $2 per share, an expected dividend growth rate of 10% and a P/E of 12.5, what is the value of the stock?
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A. B. C. D.Explanation
The next period earnings is $2.00 x 1.10 or $2.20. The value of the stock is thus the P/E ratio times the earnings = 12.5 x $2.20 or $27.50
To calculate the value of the stock, we can use the Gordon Growth Model, also known as the dividend discount model (DDM). The DDM calculates the intrinsic value of a stock by discounting its expected future dividends.
The formula for the Gordon Growth Model is: Value of Stock = Dividend / (Required Rate of Return - Dividend Growth Rate)
Let's calculate the value of the stock step by step using the given information:
Dividend: The dividend is expected to grow at a rate of 10% per year. The current earnings per share (EPS) is $2, and the payout ratio is not provided. Assuming a constant payout ratio, we can assume the dividend per share to be $2 * (1 - Payout Ratio). Since the payout ratio is not given, we'll assume it to be 100% (i.e., all earnings are paid out as dividends). Therefore, the dividend per share is $2.
Required Rate of Return: The required rate of return represents the minimum rate of return an investor expects to earn on the stock. It is subjective and can vary based on factors such as the risk associated with the stock and prevailing market conditions. However, the required rate of return is not provided in the question. Without this information, we cannot calculate the exact value of the stock.
Dividend Growth Rate: The dividend growth rate is given as 10%.
Now, let's plug the values into the formula: Value of Stock = Dividend / (Required Rate of Return - Dividend Growth Rate)
Since we don't have the required rate of return, we cannot calculate the exact value of the stock. The correct answer is C. None of these answers.
It's important to note that in real-world scenarios, stock valuation involves considering multiple factors and using different valuation methods. The Gordon Growth Model is a simplified model that assumes a constant growth rate and other simplifications, which may not reflect real-world complexities.