Question

a. Computer stocks currently provide an expected rate of return of 18%. MBI, a large computer company, will pay a year-end dividend of $2 per share. If the stock is selling at $50 per share, what must be the market's expectation of the growth rate of MBI dividends? (Do not round intermediate calculations. Round your answer to 2 decimal places.) Growth rate % b-1. If dividend growth forecasts for MBI are revised downward to 2% per year, what will be the price of the MBI stock? (Round your answer to 2 decimal places.) Price

Answer 1

(a)-Market's expectation of the growth rate of MBI dividends

Dividend in Year 1 (D1) = $2.00 per share

Current Share Price (P0) = $50.00 per share

Required Rate of Return (Ke) = 18%

Growth Rate (g) = ?

As per the Dividend Discount Model, The Current Share Price (P0) = D1 / (Ke – g)

$50.00 = $2.00 / (0.18 – g)

$2.00 / $50.00 = 0.18 – g

0.04 = 0.18 – g

g = 0.18 – 0.04

g = 0.14 or 14.00%

“Therefore, the growth rate of MBI dividends would be 14.00%”

(b)-The price of the MBI stock

Dividend in Year 1 (D1) = $2.00 per share

Current Share Price (P0) = $50.00 per share

Required Rate of Return (Ke) = 18%

Growth Rate (g) = 2% per year

As per the Dividend Discount Model, The Current Share Price (P0) = D1 / (Ke – g)

P 0 = $2.00 / (0.18 – 0.02)

= $2.00 / 0.16

= $12.50 per share

“Hence, the price of the MBI stock = $12.50”