The Merriweather Co. just announced that it is increasing its annual dividend to $1.60 and establishing a policy whereby the dividend will increase by 3.5% annually thereafter. How much will
One share of this stock be worth ﬁve years from now if the required rate of return is 12%?

Question

Quizplus · Accepted Answer

We can use the dividend discount model to calculate the future stock price:

D1 = $1.60(1.035) = $1.658
D2 = $1.658(1.035) = $1.717
D3 = $1.717(1.035) = $1.778
D4 = $1.778(1.035) = $1.841
D5 = $1.841(1.035) = $1.906

Using the constant growth formula:

P5 = D6 / (r - g) where r = required rate of return = 12% and g = growth rate = 3.5%

P5 = $1.906 / (0.12 - 0.035) = $22.36

Therefore, the stock price will be worth $22.36 five years from now, Option B is the correct answer.