Question

jessica’s pharmacy made two announcements concerning their common stock today. First, the company announced the next annual dividend will be $1.48 a share. Second, all dividends after that will increase by 2.5 percent annually. What is the maximum amount you should pay to purchase a share of this stock if your goal is to earn a 12 percent rate of return?

a $12.33

b $12.64

c $13.26

d $15.57

e $15.97

Answer 1

Solution:

The price of a share of stock is calculated using the following formula:

P₀ = D₁ / ( k_e – g )

Where

P₀ = Price of the share;      D₁ = Next Annual Dividend ; g = growth rate ;   k_e = Rate of return   ;

As per the information given in the question we have ;

D₁ = $ 1.48 ;       g = 2.5 % = 0.025 ;    k_e = 12.00 % = 0.12

Applying the above values in the formula we have

= 1.48 / ( 0.12 – 0.025)

= 1.48 / 0.095

= $ 15.57 per share ( when rounded off to two decimal places )

The price of a share of stock of Jessica's pharmacy is $ 15.57 per share.

Thus the solution is Option d. $ 15.57