Many investors use the dividend growth model to value stocks. Using the dividend payout ratio and the
Question:
Many investors use the dividend growth model to value stocks. Using the dividend payout ratio and the sustainable growth rate equation in the dividend growth model, calculate the price of a stock today, using the dividend growth model equation below. Then use your results to explain whether the company should pay a dividend or expand its manufacturing capacity.
The dividend payout ratio is one minus b, where b is the retention ratio; next year's dividend will be next year's earnings, E1, multiplied by one, minus the withholding rate: P0 = E1(1–b).
The sustainable growth rate is the return on capital multiplied by the retention ratio: Rs – ROE x b. The dividend growth model equation for calculating the price of a stock today is:
P0 = E1(1–b) /Rs – ROE xb
Corporate Finance Core Principles and Applications
ISBN: 978-1259289903
5th edition
Authors: Stephen Ross, Randolph Westerfield, Jeffrey Jaffe, Bradford Jordan