Question

Investors require a 15% rate of return on Levine Company's stock (that is, rs = 15%).What is its value if the previous dividend was D0 = $4.00 and investors expect dividends to grow at a constant annual rate of (1) -6%, (2) 0%, (3) 7%, or (4) 14%? Round answers to the nearest hundredth.Using data from part a, what would the Gordon (constant growth) model value be if the required rate of return was 15% and the expected growth rate were (1) 15% or (2) 20%? Are these reasonable results?The results show that the formula makes sense if the required rate of return is equal to or less than the expected growth rate.The results show that the formula makes sense if the required rate of return is equal to or greater than the expected growth rate.These results show that the formula does not make sense if the expected growth rate is equal to or less than the required rate of return.The results show that the formula does not make sense if the required rate of return is equal to or less than the expected growth rate.The results show that the formula does not make sense if the required rate of return is equal to or greater than the expected growth rateIs it reasonable to think that a constant growth stock could have g > rs?a.It is reasonable for a firm to grow indefinitely at a rate higher than its required return.b.It is not reasonable for a firm to grow even for a short period of time at a rate higher than its required return.c.It is not reasonable for a firm to grow indefinitely at a rate lower than its required return.d.It is not reasonable for a firm to grow indefinitely at a rate equal to its required return.e.It is not reasonable for a firm to grow indefinitely at a rate higher than its required return.

Answer 1

Answer: see Explanation

Step-by-step explanation:

Given ;

Dividend (Do) = $4

Return on investment(r) = 15% = 0.15

At annual growth rate(g) of -6% = - 0.06 ;

P = Do(1+g) ÷ (r-g)

P = 4(1+(-0.06)) ÷ (0.15 + 0.06)

P = $17.90

2.) At g = 0%

P = (4 × (1+0)) ÷ (0.15 - 0)

P = $26.67

3.) At g = 7% = 0.07

P = (4 × (1+0.07)) ÷ (0.15 - 0.07)

P = $53.50

4.) At g = 14% = 0.14

P = (4 × (1+0.14)) ÷ (0.15 - 0.14)

P = $456

Gordon model:

If rate of return is 15% and growth rate is ;

P = Do (1 + g) ÷( r - g)

P = 4(1 + 0.15) ÷ (0.15 - 0.15)

P = infinity

g = 20% = 0.2

P = Do(1 + g) ÷ (0.15 - 0.2)

P = 4(1 + 0.2) ÷ (-0.05}

P = - $96

It is not reasonable for a firm to grow indefinitely at a rate higher than its required return.