Question

A share of common just paid a dividend of $1.00. If the expected long-run growth rate for this stock is 5.4%, and if investors' required rate of return is 13.9%, what is the stock price?

a) $11.04
b) $12.40
c) $13.76
d) $15.00
e) $9.42

Answer 1

The correct option is b) $12.40.

Step-by-step explanation:

The stock price can be calculated using the Gordon growth model (GGM) formula that assumes that dividend growth rate will be stable in the long run. The formula is given as follows:

P = d / (r - g) ……………………………………… (1)

Where;

P = Stock price = ?

d = next year dividend = Dividend just paid * (1 + Dividend growth rate) = $1.00 * (1 + 0.054) = $1.00 * 1.054 = $1.054

r = required rate of return = 13.9% = 0.139

g = dividend constant growth forever = 5.4%, or 0.054

Substituting the values into equation (1), we have:

P = $1.054 / (0.139 - 0.054)

P = $1.054 / 0.085

P = $12.40

Therefore, the stock price $12.40. That is, the correct option is b) $12.40.