Elegante Homes stock traditionally provides a 16% rate of return. The company just paid an annual dividend of $3.20 a share and is expected to increase that amount by 5% per year. If you are
Planning to buy 1,000 shares of this stock next year, how much should you expect to pay per share
If the market rate of return for this type of security is 9% at the time of your purchase?

Question

Quizplus · Accepted Answer

The price of a stock can be calculated using the Gordon Growth Model: P = D1 / (r - g), where D1 is the expected dividend next year, r is the required rate of return, and g is the growth rate. Here, D1 = $3.20 * 1.05 = $3.36, r = 9% or 0.09, and g = 5% or 0.05. Thus, P = $3.36 / (0.09 - 0.05) = $84.00. However, the closest option to this calculation is $88.20, which suggests a slight discrepancy in the given options or assumptions.

Elegante Homes Stock Traditionally Provides a 16% Rate of Return