Choc Hut, Inc. normally pays a quarterly dividend. The last such dividend paid was $1.50, all future quarterly dividends are expected to grow at 6 percent, and the firm faces a required rate of return on equity of 18 percent. If the firm just announced that the next dividend will be an extraordinary dividend of $5.00 per share that is not expected to affect any other future dividends, what should the stock price be?

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Quizplus · Accepted Answer

The stock price can be calculated using the Gordon Growth Model (Dividend Discount Model) for a growing perpetuity. The extraordinary dividend is added separately. The formula is P = D1 / (r - g) + extraordinary dividend, where D1 is the next regular dividend, r is the required rate of return, and g is the growth rate. The next regular dividend is $1.50 * 1.06 = $1.59. Thus, P = $1.59 / (0.18 - 0.06) + $5.00 = $16.14.