Peterson Nurseries just paid a $3.20 annual dividend. The company has a policy whereby the dividend increases by 3% annually. You would like to purchase 100 shares of stock in this firm but realize that you will not have the funds to do so for another two years. If you desire a 12% rate of return, how much should you expect to pay for 100 shares when you can afford to buy this stock?

Question

Quizplus · Accepted Answer

The expected price of the stock in two years can be calculated using the dividend discount model. The dividend in two years will be $3.20 * (1 + 0.03)^2. The price of the stock in two years is the dividend in year 3 divided by the difference between the required rate of return and the growth rate: P2 = D3 / (r - g). Multiply the price per share by 100 to find the total cost for 100 shares.

Peterson Nurseries Just Paid a $3