Sessler Manufacturers made two announcements concerning its common stock today. First, the company announced that the next annual dividend will be $1.75 a share. Secondly, all dividends after that will decrease by 1.5 percent annually. What is the maximum amount you should pay to purchase a share of this stock today if you require a 14 percent rate of return

The maximum amount that should be paid today is $11.29

Explanation:

The constant growth model of the DDM approach can be used to calculate the price or fair value per share today based on the expected dividends that the stock will pay. As the dividends are declining n this case, the dividend growth will be negative i.e. -1.5%

The formula for the price of share today is,

P0 or V = D1  /  r - g

Thus,

P0 = 1.75 / (0.14 + 0.015)

P0 = $11.29

The maximum that should be paid for the stock today is $11.29

Explanation:

Given data

D1 = $1.75

g= -1.5%

r = 14%

The maximum you would pay for the stock today is the same as the stock price today so the Gordon Growth model is appropriate to use

SP= D1/r-g

    = 1.75/0.14- (-0.015)

    1.75/ 0.155

    =$11.29

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