The most recent dividend (Div0) from Wallboard Inc, is $0.80, the dividend growth rate (g) is expected to be 6.25%, and the required rate of return (r) on the firm's stock is 10%. What is the stock price according to the constant growth dividend model?

The stock price is $22.67

Explanation:

The constant growth model of DDM approach assumes that the dividends will grow by a constant percentage every year. To calculate the price of a stock based on this model, the formula is:

P0 = D0 * (1+g)  /  r - g

Where,

Thus,

P0 = 0.8 * (1+0.0625)  /  0.1 - 0.0625

P0 = $22.67

$22.67

Explanation: The stock price according to the constant growth dividend model would be given by applying the formula:

P = D / (r - g)

Where P is current stock price

D is next year's dividend

g is expected growth rate of dividend

r is required rate of return for the Wallboard Inc

However, next year's dividend (D) would be gotten by adding the amount gotten from the percentage growth rate of the current dividend (Do) to the current dividend thusly:

[ Do + g%(D) ] = $0.8 + (6.25% x $0.8) = 0.8 + 0.05 = $0.85

Therefore, D = $0.85

Applying the formula P = D / (r - g),

P = 0.85 / (10% - 6.25%) = 0.85/0.0375 = $22.666 = $22.67 approximately.

The constant growth model, or Gordon Growth Model as a way of valuing stock assumes that a company's dividends are going to continue to rise at a constant growth rate indefinitely. However, it is very rare for companies to show constant growth in their dividends as a result of business cycles and some unexpected financial difficulties or successes.

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