Baker Foods made two announcements concerning its common stock today. First, the company announced that the next annual dividend has been set at $3.20 a share. Secondly, the company
Announced that all future dividends after that will increase by 2% annually. What is the maximum
Amount you should pay today to purchase one share of Baker's stock if your goal is to earn a 9%
Rate of return?

Question

Quizplus · Accepted Answer

The maximum price to pay for the stock today is calculated using the Gordon Growth Model (Dividend Discount Model for a growing perpetuity): P = D1 / (r - g), where D1 is the dividend next year ($3.20), r is the required rate of return (9% or 0.09), and g is the growth rate (2% or 0.02). Plugging in the values: P = $3.20 / (0.09 - 0.02) = $45.71.

Baker Foods Made Two Announcements Concerning Its Common Stock Today