Von Bora Corporation (VBC) is expected to pay a $2.25 dividend at the end of this year. If you expect VBC's dividend to grow by 6.5% per year forever and VBC's equity cost of capital is 12.5%, then the value of a share of VBC is closest to: a. None of them. b. $51.10 c. $37.50 d. $40.00 e. $35.40
Question
Von Bora Corporation (VBC) is expected to pay a $2.25 dividend at the end of this year. If you expect VBC's dividend to grow by 6.5% per year forever and VBC's equity cost of capital is 12.5%, then the value of a share of VBC is closest to:
a. None of them.
b. $51.10
c. $37.50
d. $40.00
e. $35.40
Solution
The correct answer is d. $40.00.
Here's the step-by-step calculation:
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The value of a share of a company that pays dividends that grow at a constant rate (a "growing perpetuity") can be calculated using the Gordon Growth Model, which is P = D / (r - g), where P is the price of the stock, D is the dividend expected to be paid in the next period, r is the required rate of return, and g is the growth rate of the dividends.
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In this case, D = $2.25, r = 12.5% = 0.125, and g = 6.5% = 0.065.
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Plugging these values into the formula gives P = 40.00.
Therefore,
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