NoGrowth Industries presently pays an annual dividend of $1.70 per share and it is expected that these dividend payments will continue indefinitely. If NoGrowth's equity cost of capital is 14%, then the value of a share of NoGrowth is closest to:

Question

Quizplus · Accepted Answer

The Gordon Growth Model can be used to calculate the value of a share of stock that pays a constant dividend indefinitely. The formula is V = D/(r-g), where V is the value of the stock, D is the annual dividend per share, r is the required rate of return (or cost of equity), and g is the expected growth rate of the dividend. In this case, g = 0 since the dividend is expected to remain constant. Therefore, V = 1.70/0.14 = $12.14. However, this is the value of the stock before the ex-dividend date. On and after the ex-dividend date, the stock will trade without the dividend, so its value will be lower. Assuming a quarterly dividend, the ex-dividend date will be approximately one month before each dividend payment. Therefore, the price of the stock will drop by 1/4 of the dividend on the ex-dividend date. So, after the first dividend payment, the stock price will drop to $12.14 - $1.70/4 = $11.33. This is the value of the stock after the first dividend payment and it will remain at this level as long as the dividend continues to be paid.

NoGrowth Industries Presently Pays an Annual Dividend of $1