GTG is expected to pay a dividend of 2.50 per share next year. Calcula

QUESTION

GTG is expected to pay a dividend of 2.50 per share next year. Calculate the value of a share if dividends are expected to grow at 3.0%, the riskless rate is 5.5%, the expected market risk premium is 5.5%, and the companys beta is 1.60.The answer is 22.12, show how to solve.
To calculate this we must use two formulas: Gordon Dividend growth model CAPM model First, CAPM model. We use this to find our required rate of return on equity, a % that tells us what we must earn in return for an equity investment. This number is needed for the Gordon dividend growth model. CAPM is R(e) = Rf (Beta x Rp) where R(e) = required return on equity Rf = risk free rate beta = beta Rp = market risk premium plugging in we get: R(e) = .055 (1.6 x .055) = 14.3% Gordon growth model says: Value of stock = ((the next dividend))/(r-g) where g is growth and r¦

s the required return on equity found from CAPM plugging in we get = (2.50)/(.143-.03) = 22.12 which is the answer. Note how gordon growth states NEXT dividend payment and not the current dividend payment. If the company had paid 2.50, LAST YEAR, its next dividend payment would have been 2.50 x (1 .03) = 2.575 which reflects 3% growth. Be careful for this for future questions.

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