The earnings and dividends of Nebula Computer Co. are expected to grow at an annual rate of 15 percent over the next 4 years and then slow to a constant growth rate of 8 percent per year. Nebula currently pays a dividend of $0.50 per share. What is the value of Nebula stock to an investor who requires a 14 percent rate of return?
A) $9.31
B) $15.73
C) $11.35
D) $2.04

Question

Quizplus · Accepted Answer

Using the constant growth model formula:

P0 = D1 / (r - g)

where P0 = current stock price, 
       D1 = dividend to be received at the end of year 1, 
       r = required rate of return, 
       g = constant growth rate.

Calculating D1:

D0 = $0.50 (given)

D1 = D0 * (1 + g) = $0.50 * (1 + 0.15) = $0.575

Calculating P0:

P0 = $0.575 / (0.14 - 0.08) = $11.35

Therefore, the value of Nebula stock to an investor who requires a 14 percent rate of return is $11.35.

The Earnings and Dividends of Nebula Computer Co