Subject: Business    / Finance
Question

Problem 5. The dividend growth model is used by many investors to value stock. Using the dividend-payout ratio, and the sustainable growth rate equation in the dividend growth model, calculate the price of a share of stock today, using the following dividend growth model equation. Then use your results to explain whether the firm should pay a dividend or expand its manufacturing capability.

The dividend-payout ratio is one minus b, where b is the retention ratio; the dividend next year will be the earnings next year, E1, times one, minus the retention ratio: P0 = E1(1-b).

The sustainable growth rate is the return on equity times the retention ratio: Rs – ROE x b.

The dividend growth model equation for calculating the price of a share of stock today is:

P0 = E1(1-b)

Rs – ROE x b

Please help me to figure out the above question and how to use the formulas.

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