Question

Consider a firm that had been priced using an 11.5 percent growth rate and a 13.5 percent required return. The firm recently paid a $1.60 dividend. The firm has just announced that because of a new joint venture, it will likely grow at a 12.0 percent rate. How much should the stock price change (in dollars and percentage)? (Do not round intermediate calculations and round your final answers to 2 decimal places)

Answer 1

Using Gordon Growth Model

P₀ = D₁ / (Ke-g)

Where

P_{0 -} Current Market Price

D_{1 -} Expected next year dividend

Ke - rate of return

g - growth rate

Step 1: Calculation of market price of stock at 11.50% growth rate

P₀ = D₁ / (Ke-g)

= (1.60*1.115) / (.135-.115)

= 1.784 / .02

=$89.20

Step 2: Calculation of market price of stock at 12% growth rate

P₀ = D₁ / (Ke-g)

= (1.60*1.12) / (.135-.12)

= 1.792 / .015

= $119.47

Change in stock price (in dollars) = 119.47 - 89.20 = 30.27

Change in stock price (in percentage) = 30.27 / 89.20 * 100 = 33.93%