Question

Rancid Fruit Co. just paid a dividend of $1.00 and expects to increase it at a rate of 5% annually. All else equal, under which of the following conditions would its stock price fall in one year?

A) If the dividend in one year exceeds $1.05.

B) If the required return falls.

C) If the growth rate increases.

D) If its P/E ratio increases.

E) *If its dividend in one year is less than $1.05

Looking for the process work to understand why the answer is E) If its dividend in one year is less than $1.05

Answer 1

The current price is based on expected dividend in year 1=last dividend*(1+growth rate)=1*(1+5%)=1.05

Hence, if actual dividend is lesser, price will fall

So, price will fall if dividend is less than the expected dividend of 1.05