Sales Company paid a $1.00 dividend per share last year and is expected to continue to pay out 40% of earnings as dividends for the foreseeable future.If the firm is expected to generate a 10% return on equity in the future, and if you require a 12% return on the stock, the value of the stock is

Question

Quizplus · Accepted Answer

The value of the stock is calculated using the Gordon Growth Model (Dividend Discount Model for a perpetuity) as P = D1 / (r - g), where D1 is the dividend next year, r is the required rate of return, and g is the growth rate of dividends. Given a $1.00 dividend last year and a growth rate (g) of 6% (since the company retains 60% of earnings to grow, and the return on equity is 10%, leading to a growth rate of 0.6 * 10% = 6%), and a required return (r) of 12%, the value of the stock is calculated as $17.67, which matches choice A.

Sales Company Paid a $1