Chapter 9, Problem 1CQ

Stock Valuation Why does the value of a share of stock depend on dividends?

Summary Introduction

To determine: Whether the share value of a stock depends on the dividend.

Stock Valuation:

Stock valuation is a kind of valuation exercise of stock. In this, the value of stock is calculated theoretically and the value of firm is determined. With the help of stock valuation technique, a company can predict the future value of stock prices.

Explanation of Solution

An investor invests in a company to receive a good return in future. The value of any investment totally depends on the return, basically on the present value of the cash flows. The return on investment for the share of a stock is the dividend amount. Therefore, the value of share of the stock depends on the dividend.

Here, the stock value is the present value of cash flows and the dividend is inflow, which makes the stock value dependent on dividend value. On paying the dividends promptly, the investors’ confidence improvises. This in turn increases the stock’s demand and thereby also increases the stock prices.