Question #18
Reading: Reading 20 Discounted Dividend Valuation
PDF File: Reading 20 Discounted Dividend Valuation.pdf
Page: 7
Status: Correct
Correct Answer: A
Question
A firm currently has earnings of $3.14, and pays a dividend of $1.00, which is expected to grow at a rate of 10%. If the required return is 15%, what is the current value of the shares using the Gordon growth model?
Answer Choices:
A. $38.98
B. $22.00
C. $69.08
Explanation
P4 =
D5
r −g
CAPM : r = 0.04 + [1.4 × (0.10 −0.04)] = 0.124
D5 = D4 × (1 + g) = $1.6531 × 1.08 = $1.785
P4 =
=
= $40.57
D5
r −g
$1.785
0.124 −0.08
The Gordon growth model is used to value stocks based on a future series of dividends
that grow at a constant rate.
The current value of the shares is $22.00:
V0 = D0×(1+g) / (r-g) = [$1.00(1 + 0.10)] / (0.15 - 0.10)] = $22.00