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Fresh Foods just paid an annual dividend of $3.10 a share and is expected to increase...

Fresh Foods just paid an annual dividend of $3.10 a share and is expected to increase that amount by 4 percent per year. If you are planning to buy 1,000 shares of this stock next year, how much should you expect to pay per share if the market rate of return for this type of security is 12 percent at the time of your purchase?

a. $37.33 b. $38.16 c. $40.30 d. $41.91 e. $42.00

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Answer #1

Option (c) is correct.

As per Gordon model, share price is given by the following formula:

Value of stock or stock price = D1 / k-g

where, D1 = Dividend next year, k= required rate of return or cost of capital, g= growth rate in dividends

Next years' dividend (D1), with 4% increase = $3.1 * 104% = $3.224,

Growth rate = 4% (given), k= 12% (given)

Value of stock = $3.224 / 12% - 4%

Value of stock = $3.224 / 8%

Value of stock = $40.3

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