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Suppose a stock exhibits no dividend growth; the current dividend is $21, and the required rate of return is 7%. The share price is currently $360.
-To maintain a 7% expected rate of return with a $21 annual dividend,the expected stock price next year must be

Question

Quizplus · Accepted Answer

The expected stock price next year can be calculated using the dividend discount model for a stock with no growth, which is P0 = D / (r - g). Here, P0 is the current stock price, D is the dividend, r is the required rate of return, and g is the growth rate. Since there's no growth, the formula simplifies to P0 = D / r. To maintain a 7% return, the total return (from dividends and stock price appreciation) should equal 7%. The $21 dividend contributes to this return, so the stock price appreciation must make up the difference to reach a 7% total return on the current $360 price. The calculation is $360 * 1.07 = $385.20 as the total expected value next year. Subtracting the dividend ($21) from this gives the expected stock price of $364.20.

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