Question

Your firm is about to announce that it will pay its first dividend of $1.25 per share in five years. Afterward, the dividend will grow at 4.5%. If the market requires a 9.5% return for your stock, what should be your stock price after the announcement?

A.) $18.17

B.)$25.00

C.)$15.88

D.)$17.39

Answer 1

The price is computed as shown below:

= Dividend in year 5 / (1 + required rate of return)⁵ + 1 / (1 + required rate of return)⁵ x [ ( Dividend in year 5 (1 + growth rate) / ( required rate of return - growth rate) ]

= $ 1.25 / 1.095⁵ + 1 / 1.095⁵ [ ( $ 1.25 x 1.045) / ( 0.095 - 0.045) ]

= $ 1.25 / 1.095⁵ + $ 26.125 / 1.095⁵

= $ 27.375 / 1.095⁵

= $ 17.39 Approximately

So, the correct answer is option d.

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