Suppose that dividends are expected to grow at a rate of 10 percent for the next two years, and then 5 percent thereafter. If the current dividend is $1 per share and the required rate of return is 8 percent, the value of a share of this stock is closest to:

Question

Quizplus · Accepted Answer

The correct answer is A because the value of a share of stock is the present value of all future dividends. The present value of a dividend is the dividend divided by the required rate of return minus the growth rate. The present value of all future dividends is the sum of the present values of each dividend. In this case, the present value of the first two dividends is $1 / (0.08 - 0.10) = $5.88 and the present value of all future dividends after that is $1 / (0.08 - 0.05) * (1 / 1.05)^2 = $32.48. The total value of a share of stock is $5.88 + $32.48 = $38.36.

Suppose That Dividends Are Expected to Grow at a Rate