Question

Rapid City Motors Co. expects to grow at 20% for two years. After that it expects 8% growth indefinitely. The firm recently declared a $4.00 annual dividend. Similar stocks return about 12%. How much should a share of Rapid City be worth today?

Answer 1

To calculate the value of a share of Rapid City Motors Co. stock, we can use the Gordon Growth Model. Plugging in the given values, a share should be worth $100.00 today.

Step-by-step explanation:

To calculate the value of a share of Rapid City Motors Co. stock, we can use the Gordon Growth Model, also known as the dividend discount model. The formula for the Gordon Growth Model is:

Stock Value = D / (r - g)

Where D is the annual dividend, r is the required rate of return, and g is the growth rate. In this case, the annual dividend is $4.00, the required rate of return is 12% (given as the return of similar stocks), and the growth rate is 20% for the first two years and 8% thereafter.

Plugging in the values, we get:

Stock Value = $4.00 / (0.12 - 0.08) = $4.00 / 0.04 = $100.00

Therefore, a share of Rapid City Motors Co. stock should be worth $100.00 today.