Question #50103

Explain the valuation formula for a constant growth stock.Explain how the formula for a zero growth stock is related to that for a constant growth stock.

Expert's answer

A constant growth stock is a stock whose dividends areexpected to grow at a constant rate in the future. The value of a constant

growth stock can be determined using the following formula

P0 = (D0 ( 1+g))/(r-g)= D1/(r-g)

where

P0 = the stock price at time 0,

D0 = the current dividend,

D1 = the next dividend (i.e., at time 1), g = the growthrate in dividends, and r = the required return on the stock, and g < r.

If there is no growth of dividends g will be equal 0:

g=0

P0 = (D0 ( 1+0))/(r-0)= D/r

growth stock can be determined using the following formula

P0 = (D0 ( 1+g))/(r-g)= D1/(r-g)

where

P0 = the stock price at time 0,

D0 = the current dividend,

D1 = the next dividend (i.e., at time 1), g = the growthrate in dividends, and r = the required return on the stock, and g < r.

If there is no growth of dividends g will be equal 0:

g=0

P0 = (D0 ( 1+0))/(r-0)= D/r

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