Question

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CONSTANT GROWTH VALUATION

Holtzman Clothiers's stock currently sells for $40 a share. It just paid a dividend of $1.5 a share (i.e., D₀ = $1.5). The dividend is expected to grow at a constant rate of 3% a year.

1. What stock price is expected 1 year from now? Round your answer to two decimal places.
   $
   
2. What is the required rate of return? Round your answer to two decimal places. Do not round your intermediate calculations.
   %

Answer 1

P = $40

D0 = $1.50

growth rate (g) = 3%

Dividend 1 year from now (D1) = D0 * (1 + g) = $1.50 * 1.03 = $1.545

Required rate of return = [D1 / P] + g

Required rate of return = [$1.545 / $40] + 0.03

Required rate of return = 0.068625

Required rate of return = 6.86% (rounded off to '2' decimals)

expected Stock price 1 year from now = P0 * (1 + Ke) - D1

= $40 * (1.068625) - $1.545

= $41.20

a) expected Stock price 1 year from now = $41.20

b) Required rate of return = 6.86%