Unheardof, Inc., has just paid a dividend of 5 per share....

Unheardof, Inc., has just paid a dividend of $$\$ 5$$ per share. This dividend is anticipated to increase at a rate of $15 \%$ per year. If the cost of equity for Unheardof is $25 \%$, what should be the market value of a share of the company?

Key Concepts

Dividend Discount Model

The Dividend Discount Model is a valuation method that calculates the price of a stock by discounting all expected future dividends back to their present value. It operates under the premise that the intrinsic value of a stock is the sum of all future dividend payments, adjusted for the time value of money, which makes it central in estimating stock values for companies that distribute consistent dividends.

Constant Growth Model (Gordon Growth Model)

The Constant Growth Model, also known as the Gordon Growth Model, is a specific application of the Dividend Discount Model where dividends are assumed to grow at a constant rate indefinitely. This model simplifies valuation by using the formula P0 = D1 / (r - g), where D1 is the dividend expected next period, r is the required rate of return (cost of equity), and g is the constant growth rate of dividends.

Cost of Equity

Cost of equity is the rate of return required by investors for investing in a company's equity, reflecting the risk of the investment relative to the market. It is used as the discount rate in models such as the Dividend Discount Model to convert future dividend payments into their present value, making it a crucial component in stock valuation.

Dividend Growth Rate

Dividend growth rate is the percentage rate at which a company’s dividend is expected to increase over time. This rate is a key input in the Constant Growth Model because an accurate estimation of future dividends hinges on understanding how rapidly these dividends are likely to grow, impacting the overall valuation of the stock.

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