Question

Firm A is expected to pay a dividend of $1.00 at the end of the year. The required rate of return is rs = 11%. Other things held constant, what would the stock’s price be if the growth rate was 5%?

What if g was 0%?

Answer 1

Answer: a. If the growth rate was 5%

The stock price = D1/ke-g

= $1.00/0.11-0.05

= $1.00/0.06

= $16.67

b. If the growth rate was 0%

The stock price = $1.00/0.11-0

= $9.09

Explanation: This question relates to the determination of stock price on the assumption that dividend will be paid at the end of the year. In the formula, D1 denotes dividend at the end of the year, Ke represents required rate of return and g is the growth rate.