Question

An analyst has been following American Dream stock. He projects the following dividends for the next three years: YEAR 1 2 3 Dividend $1.84 $2.26 $3.05 The analyst notes that American Dream stock has a required return of 10.34%. The analyst projects that dividends will grow at a constant rate of 4.00% per year after year 3. What is the projected selling price for the stock at the end of year 3?

Answer 1

To find the projected selling price of American Dream stock at the end of year 3, apply the Gordon Growth Model using the given dividend, growth rate, and required return. The formula involves calculating the dividend for year 4, applying the constant growth rate, and dividing by the net of the required return minus the growth rate.

Step-by-step explanation:

The projected selling price of American Dream stock at the end of year 3 can be calculated using the Gordon Growth Model, which takes the final expected dividend payment and assumes it will grow at a constant rate indefinitely. Given that the constant growth rate after year 3 is 4.00%, and the required return is 10.34%, we can use the formula Price = Dividend at year 3 × (1 + growth rate) / (required return - growth rate). Therefore, the selling price at the end of year 3 would be calculated as follows: P3 = $3.05 × (1 + 0.04) / (0.1034 - 0.04) = $3.05 × 1.04 / 0.0634. After performing the calculation, you would get the projected selling price of the stock at the end of year 3.