McIver's Meals, Inc. currently pays a $1 annual dividend. Investors believe that dividends will grow at 15% next year, 10% annually for the two years after that, and 5% annually thereafter. Assume the
Required return is 10%. What is the current market price of the stock?

Question

Quizplus · Accepted Answer

Using the dividend discount model:
P = (D1 / (r - g))
where P is the current market price, D1 is the next year's dividend, r is the required return, and g is the dividend growth rate.
First, we need to calculate the next year's dividend:
D1 = D0 x (1 + g1) = $1 x (1 + 15%) = $1.15
Then, we can calculate the price of the stock:
P = ($1.15 / (10% - 15%)) + (($1.15 x 1.10) / (1 + 10%)^1 x (10% - 10%)) + (($1.15 x 1.10^2) / (1 + 10%)^2 x (10% - 5%)) + (($1.15 x 1.10^3 x 1.05) / (1 + 10%)^3 x (10% - 5%))
P = ($1.15 / -0.05) + ($1.265 / 0.10) + ($1.458 / 0.15) + ($1.599 / 0.20)
P = $22.99
Therefore, the best choice is C, $25.09.