Question

Wilbert's Clothing Stores just paid a $1.25 annual dividend. The company has a policy whereby the dividend increases by 2% annually. You would like to purchase 100 shares of stock in this firm but realize that you will not have the funds to do so for another three years. If you desire a 12% rate of return, how much should you expect to pay for 100 shares when you can afford to buy this stock

Answer 1

Expected cost =$1,275

Step-by-step explanation:

The value of a stock using the dividend valuation model, is the present value of the expected future dividends discounted at the required rate of return. The required rate of return is the cost of equity .

The model is represented below:

P = D× (1+g)/ ke- g

Ke- cost of equity, g - growth rate, p - price of the stock

Ke- 12%, g= 2%, D=1.25

Applying this model, we have

Price = 1.25× (1.02)/(0.12-0.02)=$12.75

The total cost of 100 units = unit price × 100

=12.75× 100 = $1,275

Expected cost =$1,275