A stock is expected to pay a dividend of $2.50 per share indefinitely. The stock is expected to generate a return of 8 percent in the foreseeable future. Based on this information, a fair price of this stock would be

Question

Quizplus · Accepted Answer

According to the Constant Growth Model:

Price of Stock = Dividend / (Required Rate of Return - Growth Rate)

We are given that the dividend is expected to be $2.50 indefinitely. We are also given that the stock is expected to generate a return of 8 percent in the foreseeable future, which can be used as the required rate of return. However, we are not given a growth rate, but we can assume that the dividend will grow at the same rate as the stock's price appreciation, so we can use the same 8 percent as the growth rate.

Plugging in the values, we get:

Price of Stock = $2.50 / (0.08 - 0.08) = $31.25

Therefore, a fair price for this stock would be $31.25, which corresponds to choice B.

A Stock Is Expected to Pay a Dividend of $2