A share of common stock has just paid a dividend of $3.00. If the expected long-run growth rate for this stock is 5 percent, and if investors require an 11 percent rate of return, what is the price of the stock?
A) $50.00
B) $50.50
C) $52.50
D) $53.00

Question

Quizplus · Accepted Answer

Using the constant-growth model, we can calculate the stock price as follows:
Price = Dividend / (Return Required - Growth Rate)
Price = $3.00 / (0.11 - 0.05)
Price = $3.00 / 0.06
Price = $50.00
However, this is the price of the stock without considering the long-run growth rate. We need to add the present value of the future cash flows that will come from the expected growth rate. We can calculate this using the formula:
Price = Dividend * (1 + Growth Rate) / (Return Required - Growth Rate)
Price = $3.00 * (1 + 0.05) / (0.11 - 0.05)
Price = $3.15 / 0.06
Price = $52.50
Therefore, the price of the stock is $52.50, which is closest to option C.

A Share of Common Stock Has Just Paid a Dividend