Coca-Cola recently paid a $3.00 dividend. Investors expect a 12 percent return on this stock. What is the difference in price if Coca-Cola is expected to grow at 6 percent versus 8 percent?

Question

Quizplus · Accepted Answer

The price of a stock using the Gordon Growth Model is calculated as $ P = \frac{D_1}{r - g} $, where $ P $ is the price, $ D_1 $ is the dividend next year, $ r $ is the required rate of return, and $ g $ is the growth rate. For a $3.00 dividend growing at 6%, the dividend next year $ D_1 $ will be $3.00 * (1 + 0.06) = $3.18. Thus, the price with a 6% growth rate is $ P = \frac{3.18}{0.12 - 0.06} = \frac{3.18}{0.06} = $53.00 $. For an 8% growth rate, $ D_1 = $3.00 * (1 + 0.08) = $3.24 $, and the price is $ P = \frac{3.24}{0.12 - 0.08} = \frac{3.24}{0.04} = $81.00 $. The difference in price is $81.00 - $53.00 = $28.

Coca-Cola Recently Paid a $3