Final answer:
The expected price of the stock two years from today, calculated using the Gordon Growth Model with a dividend growth rate of 10% and a required return of 12%, is $76.00.
Step-by-step explanation:
To calculate the expected price of a stock two years from today, we can use the Gordon Growth Model, also known as the Dividend Discount Model (DDM). This model is based on the expected dividend payment, the dividend growth rate, and the required rate of return.
Given that the dividend at the end of the first year, D1, is $1.25 and the dividends grow at a constant rate of 10% per year, the dividend at the end of the second year, D2, can be calculated as:
D2 = D1 × (1 + g) = $1.25 × (1 + 0.10) = $1.38 (rounded to two decimal places)
Since the required return is 12%, we can calculate the expected price of the stock at the end of the second year (P2) by discounting the dividend expected at the end of the third year (D3). D3 is the dividend expected to be paid at the end of the third year, which we also need to grow by 10% from D2:
D3 = D2 × (1 + g) = $1.38 × (1 + 0.10) = $1.52
Finally, we can calculate P2 as follows:
P2 = D3 / (r - g) = $1.52 / (0.12 - 0.10) = $76.00
The expected price of the stock two years from today is therefore $76.00, rounded to two decimal places.