McPherson Enterprises is planning to pay a dividend of $2.25 per share at the end of the year . After that time the dividends will grow at a constant rate of 5 percent per year. If the required return on the company's common stock is 11 percent per year, what is the current stock price?

Question

Quizplus · Accepted Answer

Using the constant growth dividend discount model:
Dividend at year 1 = $2.25(1+0.05) = $2.3625
Dividend at year 2 = $2.3625(1+0.05) = $2.4806
Dividend at year 3 = $2.4806(1+0.05) = $2.6046
...and so on
Using the formula for present value of a growing perpetuity:
PV = D/(r-g)
Where PV = current stock price, D = dividend at year 1, r = required return, and g = growth rate
PV = $2.3625/(0.11-0.05) = $39.375
Therefore, the current stock price is $39.375 which is closest to option B) $40.41.

McPherson Enterprises Is Planning to Pay a Dividend of $2