Question

Please show full work if possible, would like to be able to understand the problem and solution.

4. The dividend that was just paid for ABC stock was $3.25. The company is expected to grow at

6% in the next 4 years and then have a constant growth of 3% after that forever. The cost of

capital (equity) is 5%. What should be the stock price of this company now?

A. $153.12 B. $172.67 C. $187.33 D. $198.77 E. $213.15

Answer 1

4. The dividend just paid (D0) = $3.25

D1= $3.445

D2=$3.6517

D3=$3.8708

D4=$4.1031

Now, let us calculate , price at the end of year 4, using the Gordon Growth Model,

P4 = D5/ Re - g

= $4.1031*1.03/ 0.05 - 0.03

= $211.3097

So, the present stock price is :

= D1/1.05 + D2/1.05^2 + D3/1.05^3 + D4 /1.05^4 + $211.3097/1.05^4

= $3.445/1.05 + $3.6517/1.05^2 + 3.8708/1.05^3 + $4.1031/1.05^4 + $211.3097/1.05^4

= $187.1633

So, the correct option is option C.