Subject: Business / Finance
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.