Question

A stock is expected to pay a dividend of $1.50 at the end of the year. The required rate of return is r_s = 10.0%, and the expected constant growth rate is g = 6.0%. What is the stock's current price?

		$35.39
		$37.50
		$39.50
		$41.75
		$43.25

Answer 1

The correct answer is $37.50

This question is based on the concept of Constant Growth Dividend Discount Model.

As per Constant Growth Dividend Discount Model the dividends will grow at a constant rate forever.

We will use the formula - Price of stock = D1 / (Re - g)

Where D1 is the dividend for year 1

Re is required rate of return

g is growth rate

Stock is expected to pay a dividend of $1.50 at the end of the year. This is D1.

g = 6% or 0.06

Re = 10% or 0.10

Calculation of Price of Stock

Price of stock = D1 / (Re - g)

= $1.50 / (0.10 – 0.06)

= $1.50 / 0.04

= $37.5

The Price of stock = $37.5