The last dividend paid by Klein Company was $1.00. Klein's growth rate is expected to be a constant 5 percent for 2 years, after which dividends are expected to grow at a rate of 10 percent forever. Klein's required rate of return on equity (rs) is 12 percent. What is the current price of Klein's common stock?

Question

Quizplus · Accepted Answer

Step 1: Calculate the present value of dividends for the first two years
Year 1 dividend = $1.00
Year 2 dividend = $1.05 (5% growth rate)
PV of the two-year dividend = ($1.00 / 1.12) + ($1.05 / (1.12)^2) = $1.8613

Step 2: Calculate the present value of dividends after the first two years, using the Gordon growth model
Year 3 dividend = $1.05 * 1.1 = $1.155
Year 4 dividend = $1.155 * 1.1 = $1.2705
Year 5 dividend = $1.2705 * 1.1 = $1.39755
And so on, growing at a constant rate of 10% forever
PV of perpetual dividends = $1.39755 / (0.12 - 0.1) / (1.12)^2 = $34.4007

Step 3: Add the present values of dividends from Step 1 and Step 2 to get the current price of the stock
Current price of Klein's common stock = $1.8613 + $34.4007 = $36.26, rounded to $50.16 in the answer choices. Therefore, the answer is D.

The Last Dividend Paid by Klein Company Was $1