Consider a firm that had been priced using a 12 percent growth rate and a 16 percent required return. The firm recently paid a $5.00 dividend. The firm has just announced that because of a new joint venture, it will likely grow at a 12.5 percent rate. How much should the stock price change (in dollars and percentage)?
A) $21.50; 13.72 percent
B) $21.50; 16.14 percent
C) $20.71; 14.79 percent
D) $20.71; 19.93 percent

Question

Quizplus · Accepted Answer

The original stock price is calculated using the Gordon Growth Model: P0 = D0 * (1 + g) / (r - g), where D0 is the dividend just paid, g is the growth rate, and r is the required return. Initially, P0 = $5 * (1 + 0.12) / (0.16 - 0.12) = $5 * 1.12 / 0.04 = $140. After the growth rate changes to 12.5%, the new price is P1 = $5 * (1 + 0.125) / (0.16 - 0.125) = $5 * 1.125 / 0.035 = $160.71. The change in price is $160.71 - $140 = $20.71. The percentage change is ($20.71 / $140) * 100 = 14.79%.

Consider a Firm That Had Been Priced Using a 12