Constant Growth Stock Valuation Best Buy Co.(BBY)paid a $0.27 dividend per share in 2003,which grew to $0.49 in 2007.This growth is expected to continue.What is the value of this stock at the beginning of 2007 when the required rate of return is 17.23 percent?

Question

Quizplus · Accepted Answer

To calculate the intrinsic value of the stock using the constant growth model, we can use the formula:

Value of stock = D1 / (k - g)

where D1 is the dividend paid in the next period, k is the required rate of return, and g is the expected growth rate of dividends.

In this case, we know that: 
D0 = $0.27 (dividend paid in 2003) 
D1 = $0.49 (dividend paid in 2007) 
k = 17.23% 
g = (D1 / D0) - 1 
g = ($0.49 / $0.27) - 1 
g = 0.815 - 1 
g = -18.5%

Note that we have a negative growth rate. This might happen when the growth rate is less than the required rate of return, which means that the company is not performing well. In this case, we can still use the formula and get a negative intrinsic value, which means that the stock is overvalued.

Plugging the values into the formula, we get:

Value of stock = $0.49 / (17.23% - (-18.5%)) 
Value of stock = $0.49 / 35.73% 
Value of stock = $1.37

Therefore, the value of the stock at the beginning of 2007 is $1.37, which is closest to option C ($49.03).