Company X has 100 shares outstanding. It earns $1,000 per year and expects to pay all of it as dividends. If the firm expects to maintain this dividend forever, calculate the stock price after the dividend payment. (The required rate of return is 10 percent.)

Question

Quizplus · Accepted Answer

To calculate the stock price after the dividend payment we use the Gordon Growth Model.

Stock price = (Dividend per share next year) / (Required rate of return - Dividend growth rate)

Since the company expects to pay all earnings as dividends, the dividend per share next year will be $1,000 / 100 shares = $10 per share.

The dividend growth rate is zero, since the company expects to maintain the same dividend forever.

Therefore: 
Stock price = $10 / (0.10 - 0) = $100

So the correct answer is B.

Company X Has 100 Shares Outstanding