The ABC Co. has paid annual dividends of $0.30, $0.64, $1.20, and $1.45 over the past four years. Dividends in the future are expected to grow at a constant rate of 3.5%. Which one of the following
Formulas should be used to compute the value of the stock today?

Question

Quizplus · Accepted Answer

This problem requires the use of the constant growth dividend discount model. The formula for this model is PS0 = D1 / (r – g), where PS0 is the stock price today, D1 is the expected dividend in the next period, r is the required rate of return, and g is the constant growth rate of dividends. In this case, we are given that dividends are expected to grow at a constant rate of 3.5% and we are asked to compute the value of the stock today. Based on the formula above, we can use choice D, P₀ = D₁/(r - g), to compute the value of the stock today. This formula is equivalent to the constant growth dividend discount model formula. Therefore, the best choice for computing the value of the stock today is D.