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How much should you pay for a share of stock that offers a constant growth rate of 10%, requires a 16% rate of return, and is expected to sell for $53.17 one year from now
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22 votes
22 votes
How much should you pay for a share of stock that offers a constant growth rate of 10%, requires a 16% rate of return, and is expected to sell for $53.17 one year from now

User Sharad Kale
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1 Answer

11 votes
11 votes

Answer: $48.33

Step-by-step explanation:

Using the Gordon Growth model:

Price of stock = Next year dividend / (Required return - growth rate)

Next year price of stock can be used to calculate year 2 dividend:

53.17 = D₂ / ( 16% - 10%)

53.17 * 6% = D₂

D₂ = $3.19

D₂ = D₁ * ( 1 + growth rate)

3.19 = D₁ * ( 1 + 10%)

D₁ = 3.19/ 1.1

= $2.90

Price of stock today:

= 2.90 / ( 16% - 10%)

= $48.33

User Bleevo
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