Asked by Camila Ramirez on Jul 06, 2024
Verified
Consider a share of stock that pays a dividend of $1 at the end of one year, $2 at the end of two years, and then dividends grow at a constant rate of 5% per year thereafter. If the required return is 10%, we can value this share of stock by finding P2 using D3, then find P0 = D1/(1.1) + D2/(1.1)2 + P2/(1.1)1. In this formula, it appears as though we ignore all dividends from year three on. Why is this so?
Dividend
A fraction of a corporation's profits allocated to its stockholders, often as cash or more shares.
Required Return
This is the minimum return an investor expects to receive on an investment, factor in the risk involved.
- Gain insight into the core principles of the dividend growth model and how it aids in stock valuation.
Verified Answer
AR
Amber ReneeJul 10, 2024
Final Answer :
We actually don't ignore any dividends. When we compute (P2we incorporate dividend number three, but also all dividends from that point forward) Thus, we have included all dividends in the stock valuation, which is required in order to determine the value of a share.
Learning Objectives
- Gain insight into the core principles of the dividend growth model and how it aids in stock valuation.