Woidtke Manufacturing's stock currently sells for 20 a...

Woidtke Manufacturing's stock currently sells for $\$ 20$ a share. The stock just paid a dividend of $\left.\$ 1.00 \text { a share (i.e., } D_{0}=\$ 1.00\right),$ and the dividend is expected to grow for ever at a constant rate of $10 \%$ a year. What stock price is expected 1 year from now? What is the required rate of return on Woidtke's stock?

Key Concepts

Stock Price Forecasting Using Constant Growth

When dividends grow at a constant rate, future stock prices can be forecasted by applying the constant growth rate to current values derived from the dividend discount model. The theoretical price one period ahead is determined by reapplying the model to the next period’s dividend, showing how the appreciation component in the model is largely driven by the dividend growth rate.

Required Rate of Return

The required rate of return is the minimum return investors expect to receive from an investment in a stock, considering the risks involved. In the context of the dividend discount model, it is typically computed as the sum of the dividend yield and the dividend growth rate, reflecting both income and capital appreciation portions of the return.

Dividend Growth Rate

The dividend growth rate is the constant rate at which a company’s dividends are expected to increase over time. It is essential in the dividend discount model, as it helps determine both the future dividends and the growth component that contributes to the stock's total return.

Dividend Discount Model (Gordon Growth Model)

This model values a stock by assuming that dividends will increase at a constant rate forever. The current price is calculated by dividing the dividend expected in the next period by the difference between the required rate of return and the constant growth rate. It provides a theoretical framework linking dividend patterns and overall stock valuation.

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