Gillette Corporation will pay an annual dividend of $0.61 one year from now. Analysts expect this dividend to grow at 12.2% per year thereafter until the 5th year. Thereafter, growth will level off at 1.8% per year. According to the dividend-discount model, what is the value of a Gillette share if the firm's equity cost of capital is 7.4%?
Question
Gillette Corporation will pay an annual dividend of $0.61 one year from now. Analysts expect this dividend to grow at 12.2% per year thereafter until the 5th year. Thereafter, growth will level off at 1.8% per year. According to the dividend-discount model, what is the value of a Gillette share if the firm's equity cost of capital is 7.4%?
Solution
To calculate the value of a Gillette share, we need to use the Dividend Discount Model (DDM). The DDM is a method of valuing a company's stock price based on the theory that its stock is worth the sum of all of its future dividend payments, discounted back to their present value.
Here's how to calculate it step by step:
- Calculate the dividends for the first 5 years. The dividend is expected to grow at 12.2% per year for the first 5 years.
Year 1: 0.61 * (1 + 12.2%) = 0.6842 * (1 + 12.2%) = 0.7672 * (1 + 12.2%) = 0.8605 * (1 + 12.2%) = $0.9653
- Calculate the present value of these dividends. The firm's equity cost of capital is 7.4%, so we'll use this as the discount rate.
PV Year 1: 0.568 PV Year 2: 0.594 PV Year 3: 0.618 PV Year 4: 0.640 PV Year 5: 0.660
- Calculate the present value of all future dividends from Year 6 onwards. From Year 6 onwards, the dividend growth rate will level off at 1.8%. We can use the Gordon Growth Model (a version of the DDM) to calculate this.
PV Year 6 onwards = D6 / (r - g) = (15.96
- The value of a Gillette share is the sum of the present value of all these dividends.
Value of share = PV Year 1 + PV Year 2 + PV Year 3 + PV Year 4 + PV Year 5 + PV Year 6 onwards = 0.594 + 0.640 + 15.96 = $18.04
So, according to the dividend-discount model, the value of a Gillette share is approximately $18.04.
Similar Questions
A company has been paying a $0.68 dividend and as it faces no growth opportunities it is expected that the dividend will not change in the future. If investors require a 24.98% return for this company, what is the share value. (Please round your answer to the nearest cent but exclude the $ sign when typing your answer.)
The Co. just paid a dividend of $1 per share. Analysts expect its dividend to grow at 25 percent per year for the next three years and then 5 percent per year thereafter. If the required rate of return on the stock is 18 percent, what is the current value of the stock?
Kiffer SARL just paid a dividend of €0.85 on its stock.They expect dividends to grow at a rate of 8% in the next three years and 5% per year thereafter.Given a required rate of return of 15%, what is the current value of the company's common stock?€8.28€9.64€10.41€11.24€12.41
StartUp Corporation has just paid a dividend of $1.15 per share. The firm pays annual dividends. It is expected by analysts that the earnings of StartUp will grow by 8.2% per year over the next six years. After that, the earnings will most likely grow at the current industry average of 5.5% per year. Analysts do not expect any changes in the payout ratio of the firm. The cost of capital is 10.0%. What is StartUp’s share price?Question 11Answera.$30.93b.$32.08c.$29.86d.$52.52
Assume Stanton Corporation will pay an annual dividend of $3.24 one year from now. Analysts expect this dividend to grow at 14% p.a. thereafter until the third year. After then, growth will level off at 4.1% p.a.. The firm’s equity cost of capital is 9.7% p.a.. What is the intrinsic value of Stanton Corporation? All of these rates are compounded annually. (
Upgrade your grade with Knowee
Get personalized homework help. Review tough concepts in more detail, or go deeper into your topic by exploring other relevant questions.