Question

setla, co. just paid an $0.85 annual dividend. the company has a policy whereby the dividend increases by 2% annually. you would like to purchase 500 shares of stock in this firm but realize that you will not have the funds to do so for another two years. if you desire a 12.50% rate of return, how much should you expect to pay for 500 shares when you can afford to buy this stock? multiple choice $4,048 $4,129 $4,211 $4,295 $4,469

Answer 1

To determine the expected cost for 500 shares of Setla Co., we use the Gordon Growth Model to estimate the future stock price accounting for dividend growth and discount it to present value to accommodate the required rate of return.

Step-by-step explanation:

In finding out how much to pay for 500 shares of Setla Co., we need to calculate the present value of the future dividends you expect to receive once you purchase the stock. Since Setla Co. is expected to grow its dividends at 2% annually and the required rate of return is 12.50%, we can use the Gordon Growth Model (a dividend discount model) to estimate the price of the stock two years from now.

The formula for the Gordon Growth Model, also known as the Dividend Discount Model, is:
Price = D0 * (1 + g) / (r - g),
where D0 is the most recent dividend payment, g is the growth rate of the dividends, and r is the required rate of return.

However, since we want to find the present value of those future prices, we then discount it back by two years using the required rate of return: Present Value = Future Value / (1 + r)^n.

Calculating this will give us the expected price to pay today for a future investment opportunity, bearing in mind the desired rate of return and the projected growth in dividends.