Question

Investors require a 17% rate of return on Levine Company's stock (that is, r_s = 17%).

1. What is its value if the previous dividend was D₀ = $2.00 and investors expect dividends to grow at a constant annual rate of (1) -2%, (2) 0%, (3) 2%, or (4) 10%? Round answers to the nearest hundredth.
   (1) $   
   (2) $   
   (3) $   
   (4) $   
   
2. 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?  
   
   1. 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.
   2. 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.
   3. 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 rate.
   4. The results show that the formula makes sense if the required rate of return is equal to or less than the expected growth rate.
   5. The results show that the formula makes sense if the required rate of return is equal to or greater than the expected growth rate.
   
   -Select one
   
3. Is it reasonable to think that a constant growth stock could have g > r_s?
   
   1. It is not reasonable for a firm to grow even for a short period of time at a rate higher than its required return.
   2. It is not reasonable for a firm to grow indefinitely at a rate lower than its required return.
   3. It is not reasonable for a firm to grow indefinitely at a rate equal to its required return.
   4. It is not reasonable for a firm to grow indefinitely at a rate higher than its required return.
   5. It is reasonable for a firm to grow indefinitely at a rate higher than its required return.
   
   -Select one
   

Answer 1

As per DDM model
1)Price of Stock =Do*(1+g)/(Re-g)
At growth of -2%
Price of Stock =2*(1-2%)/(17%+2%) =10.32
2)At growth of 0%
Price of Stock =2*(1+0%)/(17%-0%) =11.76
3)At growth of 2%
Price of Stock =2*(1+2%)/(17%-2%) =13.60
4)At growth of 10%
Price of Stock =2*(1+10%)/(17%-10%) =31.43

b)At growth of 15%
Price of Stock =2*(1+15%)/(17%-15%) =115.00

At growth of 20%
Price of Stock =2*(1+20%)/(17%-20%) =-80.00


Option II is correct option if required rate is less or equal to growth results don't make sense

c) Option IV is correct option