Question

Biggs Inc., just paid a dividend of $.50. It is expected to increase its dividend by 2% per year. If the market requires a return of 15% on assets of this risk level, how much should the stock be selling for?

a. $4.92
b. $5.02
c. $3.92
d. $0.51

Answer 1

Using the Dividend Discount Model, Biggs Inc. stock should be valued at $3.92, considering the initial dividend, growth rate, and required rate of return.

Step-by-step explanation:

The price of Biggs Inc. stock can be calculated using the Dividend Discount Model (DDM), which takes into account the current dividend paid, the growth rate of the dividend, and the required rate of return. Since Biggs Inc. just paid a dividend of $0.50 and expects this to increase by 2% per year, the next year's dividend will be $0.51 ($0.50 * 1.02). Given the required return of 15%, the value of the stock (P) is calculated as the next year's dividend (D1) divided by the difference between the required rate of return (r) and the dividend's growth rate (g), meaning P = D1 / (r - g). Plugging in the values gives us P = $0.51 / (0.15 - 0.02) = $0.51 / 0.13 = $3.92. Therefore, the correct answer is $3.92.