Cullumber Corp. paid a dividend of $2.44 yesterday. The company’s dividend is expected to grow at a steady rate of 5 percent for the foreseeable future. If investors in stocks of companies like Cullumber require a rate of return of 25 percent, what should be the market price of Cullumber stock? (Round dividend to 3 decimal places, e. g. 3.756 and round final answer to 2 decimal places, e. g. 15.25.)

The market price is $12.81 per share.

Explanation:

The price of the stock today can be calculated using the constant growth model of DDM as the dividends are expected to grow at a constant rate. The formula to calculate the price of the stock under constant growth model is,

P0 = D1 / r-g

Where,

P0 = 2.44 * (1+0.05)  /  (0.25 - 0.05)

P0 = $12.81

The market price of Cullumber stock should be $12.81.

Explanation:

To calculate the market price of Cullumber stock, we use the dividend discount model (DDM) formula stated as follows:

P = Next year dividend ÷ (r - g) (1)

Where,

P = stock market price = ?

Next year dividend = Do × (1 + 0.05) = $2.44  × 1.05 = $2.562

r = required return = 25% = 0.25

g = dividend growth rate = 5% = 0.05

These above values are now substituted into equation (1) as follows:

P = $2.562 ÷ (0.25 - 0.05) = $2.562 ÷ 0.20 = $12.81

Therefore, the market price of Cullumber stock should be $12.81.