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A company is growing at a constant rate of 8%. Last week it paid a dividend of $3.00. If the required rate of return is 15%, what is the price of the share three years from now?

My initial thought was to calculate the present value, and then just compound it to a FV that is 3 years from now.

Here's what I did,

PV = 3/ (0.15-0.08)

and then FV = PV(1.15)^3 = $65.18

But this is apparently incorrect. The correct answer is 58.31 according to my book. Why is that?

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  • ((3 * 1.08) / (0.15-0.08)) * (1.08 ^ 3) = 58.31, but I don't know whether or not it's correct because I found it by randomly plugging in the numbers.
    – Flux
    Sep 12, 2021 at 12:59

1 Answer 1

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One of the most commonly used dividend discount models is the Gordon Growth Model (GGM). The formula of the GGM is:

P = D / (r - g)

where

  • P is the current value of the stock.
  • D is the dividend payment at the end of the current period.
  • r is the required rate of return.
  • g is the dividend growth rate.

In three years' time, D = 3 * (1.08 ^ 4) = $4.08

Plugging this D into the formula, we get:

P = (3 * (1.08 ^ 4)) / (0.15 - 0.08)

P = $58.31

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