Shackleford Corporation net income this year is $800,000.The company generally retains 35% of net income for reinvestment.The company's common equity currently has a book value of $5,000,000.They just paid a dividend of $1.37,and the required rate of return on this stock is 12%.Compute the value of this stock if dividends are expected to continue growing indefinitely at the company's internal growth rate.

Question

Quizplus · Accepted Answer

The value of the stock can be calculated using the Gordon Growth Model (Dividend Discount Model for a perpetually growing dividend), which is P = D1 / (k - g), where P is the price of the stock, D1 is the dividend next year, k is the required rate of return, and g is the growth rate. The growth rate (g) can be found by the retention ratio (b) times the return on equity (ROE), where ROE = Net Income / Equity. Here, g = b * ROE = 0.35 * ($800,000 / $5,000,000) = 0.35 * 0.16 = 0.056 or 5.6%. The dividend next year (D1) is $1.37 * (1 + g) = $1.37 * (1 + 0.056) = $1.44872. Plugging these values into the Gordon Growth Model gives P = $1.44872 / (0.12 - 0.056) = $22.61.

Shackleford Corporation Net Income This Year Is $800,000