The Brown Company just announced that it will be increasing its annual dividend to $1.68 next year and that future dividends will be increased by 2.5% annually. How much would you be willing to pay for one share of the Brown Company stock if you require a 12% rate of return?
A) $14.35
B) $14.63
C) $17.68
D) $18.13
E) $19.81

Question

Quizplus · Accepted Answer

The price of the stock can be calculated using the Gordon Growth Model (Dividend Discount Model for a growing dividend), which is P = D1 / (r - g), where D1 is the dividend next year, r is the required rate of return, and g is the growth rate. Here, D1 = $1.68, r = 12% or 0.12, and g = 2.5% or 0.025. Plugging in these values gives P = $1.68 / (0.12 - 0.025) = $17.68.

The Brown Company Just Announced That It Will Be Increasing