Question

Defenestration Industries plans to pay a $4.00 dividend this year and you expect that the firm's earnings are on track to grow at 5% per year for the foreseeable future. Defenestration's equity cost of capital is 13%. Assuming that Defenestration's dividend payout rate and expected growth rate remain constant, and Defenestration does not issue or repurchase shares, then Defenestration's stock price is closest to:

A. $50.00
B. $32.30
C. $22.25
D. $30.75

Answer 1

Using the Gordon Growth Model with a dividend of $4.00, a cost of capital of 13%, and a growth rate of 5%, the stock price of Defenestration Industries is calculated to be $50.00, which is option A.

Step-by-step explanation:

The stock price of Defenestration Industries can be determined using the Gordon Growth Model (also known as the Dividend Discount Model), which calculates the present value of an infinite series of future dividends that are expected to increase at a constant rate. The formula for the Gordon Growth Model is P = D / (k - g), where P is the price of the stock, D is the expected dividend per share, k is the equity cost of capital, and g is the growth rate of dividends.

For Defenestration Industries, the expected dividend, D, is $4.00, the cost of capital, k, is 13% (or 0.13 as a decimal), and the growth rate, g, is 5% (or 0.05 as a decimal). Using these values, the stock price is calculated as follows:
P = 4 / (0.13 - 0.05) = 4 / 0.08 = $50.00. Therefore, the stock price of Defenestration Industries is closest to $50.00, which is option A.