Question

Cape Corp. will pay a dividend of $3.00 next year. The company has stated that it will maintain a constant growth rate of 4.5 percent a year forever.

a. If you want a return of 15 percent, how much will you pay for the stock?
b. If you want a return of 8 percent, how much will you pay for the stock?

Answer 1

a.

$27.27

b.

$75

Step-by-step explanation:

Use the following formula to calculate the value of the stock

Value of Stock = Expected Dividend / ( Rate of return - Growth rate )

a.

Where

Expected Dividend = $3.00

Rate of return = 15%

Growth rate = 4.5%

Placing values in the formula

Value of Stock = $3.00 / ( 15% - 4% )

Value of Stock = $3 / 11%

Value of Stock = $27.27

b.

Where

Expected Dividend = $3.00

Rate of return = 8%

Growth rate = 4.5%

Placing values in the formula

Value of Stock = $3.00 / ( 8% - 4% )

Value of Stock = $3 / 4%

Value of Stock = $75