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Suppose that the rate of interest is 10% and a company expects its annual dividend payments...

Suppose that the rate of interest is 10% and a company expects its annual dividend
payments to grow at a rate of 6%. The price of the stock is set at $100. Answer the
following questions using the fundamentalist approach.
a) What is the company’s expected annual dividend payment?
b) What would be the price of the stock if the rate of interest decreased to 8%?
c) What would be the price of the stock if the expected growth rate of dividends also
decreased to 4%?

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Answer #1

a

Price = Dividend in 1 year/(cost of equity - growth rate)
100 = Dividend in 1 year/ (0.1 - 0.06)
Dividend in 1 year = 4

b

Price = Dividend in 1 year/(cost of equity - growth rate)
Price = 4/ (0.08 - 0.06)
Price = 200

c

Price = Dividend in 1 year/(cost of equity - growth rate)
Price = 4/ (0.08 - 0.04)
Price = 100
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