Problem 5. The dividend growth model is used by many investors to value stock. Using thedividend-payout ratio, and the sustainable growth rate equation in the dividend growth model,calculate the price of a share of stock today, using the following dividend growth modelequation. Then use your results to explain whether the firm should pay a dividend or expand itsmanufacturing capability.

The dividend-payout ratio is one minus b, where b is the retention ratio; the dividend nextyear will be the earnings next year, E1, times one, minus the retention ratio: P0 = E1(1b). The sustainable growth rate is the return on equity times the retention ratio: Rs ROE x b.The dividend growth model equation for calculating the price of a share of stock today is:

P0 = E1(1b) / Rs ROE x b