Question

you believe that the baruch factory will pay a dividend of $5 on its common stock next year. thereafter, you expect dividends to grow at a rate of 2% a year in perpetuity. if you require a return of 15% on your investment, how much should you be prepared to pay for the stock? (do not round intermediate calculations. round your answer to 2 decimal places.)

Answer 1

Using the Gordon Growth Model, if Baruch Factory is expected to pay a $5 dividend next year with a 2% perpetual growth and you require a 15% return, you should pay $38.46 for the stock.

Step-by-step explanation:

To calculate the value of a stock based on expected dividends, we use the Gordon Growth Model (also known as the Dividend Discount Model). In this scenario, you believe that the Baruch Factory will pay a dividend of $5 next year, and you expect the dividends to grow at a rate of 2% per year indefinitely. Given that you require a return of 15% on your investment, you can calculate the price you should be prepared to pay using the formula:

P = D / (r - g)

where P is the price, D is the next year’s dividends, r is the required rate of return, and g is the growth rate.

Here, P = 5 / (0.15 - 0.02) = 5 / 0.13 = $38.46. Therefore, you should be prepared to pay $38.46 for the stock.