Question

The required return for Williamson Heating's stock is 12%, and the stock sells for $40 per share. The firm just paid a dividend of $1.00, and the dividend is expected to grow by 30% per year for the next 4 years, so D₄ = $1.00(1.30)⁴ = $2.8561. After t = 4, the dividend is expected to grow at a constant rate of X% per year forever. What is the stock's expected constant growth rate after t = 4, i.e., what is X?

Select the correct answer.

a. 7.46%

b. 8.70%

c. 8.26%

d. 7.08%

e. 7.85%

Answer 1

Value of share = Present value of dividends and terminal value discounted at required return

Terminal Value = a * (1+g)/(r-g)

40 = 1*(1.30)^1/(1+0.12)^1 + 1*(1.30)^2/(1+0.12)^2 +1*(1.30)^3/(1+0.12)^3 +1*(1.30)^4/(1+0.12)^4 + {1*(1.30)^4*(1+g) / (r-g) }/(1+0.12)^4

40 = 5.89 + (1.3^4/1.12^4)*(1+g)/(0.12-g)

18.79405 = (1+g)/(0.12-g)

18.79405 *0.12 - 18.79405 *g = 1 + g

g = 6.34% Answer

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