The JLP company is expected to pay a dividend of $1.75 per share every yearindefinitely and the equity cost of capital for the company is 7.5%. What price wouldan investor be expected to pay per share 10 years in the future? O a. S25.00 O b. S23.33 O c. S41.68 O d. $33.34
Question
The JLP company is expected to pay a dividend of 33.34
Solution
The price of a share of a company that pays a constant dividend indefinitely can be calculated using the Gordon Growth Model, which is a version of the Dividend Discount Model (DDM). The formula is:
P = D / r
where: P = price of the stock D = dividend per share r = equity cost of capital (or required rate of return)
In this case, the dividend (D) is $1.75 per share and the equity cost of capital (r) is 7.5% or 0.075.
However, since the question asks for the price an investor would be expected to pay per share 10 years in the future, and the dividend is constant indefinitely, the price of the stock would be the same as it is today. This is because the price of a perpetuity (which this stock essentially is, since it pays a constant dividend indefinitely) does not change over time.
So, we can plug the given values into the formula:
P = 23.33
Therefore, the correct answer is:
O b. $23.33
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