Mortgage Instruments NV is expected to pay dividends of €1.03 next year.The company just paid dividends of €1.This growth rate is expected to continue.How much should be paid for Mortgage instruments share just after the dividend if the appropriate discount rate is 5%.
A)€20.00
B)€21.50
C)€34.75
D)€50.00
E)€51.50

Question

Quizplus · Accepted Answer

The value of a stock can be calculated using the Gordon Growth Model (also known as the Dividend Discount Model for a perpetuity with growth) when dividends are expected to grow at a constant rate indefinitely. The formula is P = D / (r - g), where P is the price of the stock, D is the dividend next year, r is the required rate of return (discount rate), and g is the growth rate of the dividend. Here, D = €1.03, r = 5% or 0.05, and g = 3% or 0.03 (since the dividend grows from €1 to €1.03, which is a 3% increase). Plugging these values into the formula gives P = €1.03 / (0.05 - 0.03) = €1.03 / 0.02 = €51.50.

Mortgage Instruments NV Is Expected to Pay Dividends of €1