Question

Rogue Motors Inc. has a 11% required rate of return. The firm does not expect to initiate dividends for 10 years, at which time it will pay $2.00 per share in dividends. At that time, the firm expects its dividends to grow at 6% forever. What is an estimate of the firms' price in 10 years (P10) if its dividend at the end of year 10 is $2.00?Group of answer choicesa. $31.20b. $42.40c. $42.80d. $33.40

Answer 1

The correct answer is B that is $42.40

Step-by-step explanation:

As per the dividend discount model, present price of the share is the present value of future dividend is computed as:

Price of the firm in 10 years = Dividend at the end of the year 10 × (1 + Growth rate in dividends) / (Required return - Growth rate in dividends)

where

Dividend at the end of the year 10 is $2.00

Growth rate in dividends is 6%

Required return is 11%

Putting the value above,

= $2.00 × (1 + 6%) / (11% - 6%)

= $2.00 × (1 + 0.06) / 5%

= $2.00 × 1.06 / 0.05

= $ 2.12 / 0.05

= $42.4