The stock of Robotic Atlanta Inc. is trading at $ 33.21 per share. In the past,
ID: 2820254 • Letter: T
Question
The stock of Robotic Atlanta Inc. is trading at $ 33.21 per share. In the past, the firm has paid a constant dividend of $ 4.31 per share and it has just paid an annual dividend (i.e., D0 = 4.31 ). However, the company will announce today new investments that the market did not know about. It is expected that with these new investments, the dividends will grow at 10.0 % forever. Assuming that the discount rate remains the same, what will be the price of the stock after the announcement? Calculate your answer to the nearest penny, do not use the $ sign in your answer.
Explanation / Answer
Step 1 – Calculation of “r”
Since, the company has been paying constant dividend for the past year, therefore, As per the Constant Growth Dividend valuation model
r = [D0 / P0] x 100
= [$4.31 / $33.21] x 100
= 12.98%
Step 2 – Calculation of price of the stock after the announcement
In case of growth in dividend, the Price of the stock is calculated by using the following formula
P0 = D0[1+g] / (r – g)
Where, P0 = price of the stock
g = Growth Rate
r = The required rate of return calculated above
Therefore, P0 = D0[1+g] / (r – g)
= $4.31[1 + 0.10] / (0.1298 – 0.10)
= $4.74 / 0.0298
= $159.09
“Hence, The price of the stock after the announcement = $159.09”
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