Question

1. Suppose the company is expected to pay a divided of $2.5 and the required rate of return is 10% and the growth rate is 4%. What is the price of the stock after 5 years? after 10 years? after 12 years?

2. Suppose the company just paid a divided of $2.5 and the required rate of return is 10% and the growth rate is 4%. What is the price of the stock after 5 years? after 10 years? after 12 years?

3. ABC’s stock is currently selling for $60 per share. The firm is expected to pay a dividend of $3.60. If the cost of equity is 9%, compute the growth rate.

Answer 1

1. a. Price After 5 Years

Expected Dividend will be paid after 5 years = Current Dividend * (1 + growth Rate) ^5

Expected Dividend will be paid after 5 years = $2.50 * (1 + 0.04) ^5

Expected Dividend will be paid after 5 years = $3.04

Price of Stock = Dividend After 5 Years * (1 + Growth Rate) / (Required Rate - Growth Rate)

Price of Stock = $3.04 * (1 + 0.04) / (0.10 - 0.04)

Price of Stock = $52.72

b. Price After 10 Years

Expected Dividend will be paid after 10 years = Current Dividend * (1 + growth Rate) ^12

Expected Dividend will be paid after 10 years = $2.50 * (1 + 0.04) ^10

Expected Dividend will be paid after 10 years = $3.70

Price of Stock = Dividend After 10 Years * (1 + Growth Rate) / (Required Rate - Growth Rate)

Price of Stock = $3.70 * (1 + 0.04) / (0.10 - 0.04)

Price of Stock = $64.14

c. Price After 12 Years

Expected Dividend will be paid after 12 years = Current Dividend * (1 + growth Rate) ^12

Expected Dividend will be paid after 12 years = $2.50 * (1 + 0.04) ^12

Expected Dividend will be paid after 12 years = $4.00

Price of Stock = Dividend After 10 Years * (1 + Growth Rate) / (Required Rate - Growth Rate)

Price of Stock = $4.00 * (1 + 0.04) / (0.10 - 0.04)

Price of Stock = $69.38

2. Growth Rate

Stock Price = Dividend * (1 + Growth Rate) / (Required Rate - Growth Rate)

$60 = $3.60 / (9% - x%)

$5.40 - $60 * x% = $3.60

$60.00 * x% = $1.80

Growth Rate = 3%