Consider a firm that had been priced using a 10 percent growth rate and a 14 percent required rate. The firm recently paid a $1.00 dividend. The firm has just announced that because of a new joint venture, it will likely grow at a 12 percent rate. How much should the stock price change (in dollars and percentage)?
A) $25, 1 percent
B) $25, 100 percent
C) $28.50, 1.04 percent
D) $28.50, 104 percent

Question

Quizplus · Accepted Answer

The original stock price with a 10 percent growth rate is calculated using the Gordon Growth Model: P0 = D0 * (1 + g) / (r - g) = $1 * (1 + 0.10) / (0.14 - 0.10) = $27.50. With the growth rate increasing to 12 percent, the new price is: P1 = $1 * (1 + 0.12) / (0.14 - 0.12) = $56. The change in price is $56 - $27.50 = $28.50, which is a 104 percent increase ($28.50 / $27.50).

Consider a Firm That Had Been Priced Using a 10