Question

Gerdin Inc. just paid out its annual dividend of $2/share.

The dividend is expected to grow at 50% a year for the next 2 years.

Afterwards, the annual growth rate will be settled at 5% indefinitely.

The required rate of return of the stock is 15%.

Find out the expected stock price at the end of year 2.

$45

$47.25

$41.74

$43.74

$50

Answer 1

Ans: Expected stock price at the end of year 1 = Dividend paid * ( 1+ growth rate)

= $ 2 * ( 1+ 50%)

= $ 2 * ( 1.5)

= $ 3

Expected stock price at the end of year 2 = Expected stock price at the end of year 1 * ( 1+ growth rate)

= $ 3 * (1 + 50 %)

= $ 3 * ( 1.5)

= $ 4.5

Expected stock price at the end of year 2 = Dividend that is paid next year / expected rate of return - growth rate

= $ 4.5 * ( 1+ growth ) / 0.15 - 0.05

= $ 4.5* (1.05) / 0.10

= $ 4.725 / 0.1

= $ 47.25

option B