Fred Flintlock wants to earn a total of 10% on his investments. He recently purchased shares of ABC stock at a price of $20 a share. The stock pays a $1 a year dividend. The price of ABC stock needs
To _____ if Fred is to achieve his 10% rate of return.

Question

Quizplus · Accepted Answer

To find out what price the stock needs to be at for Fred to achieve a 10% rate of return, we need to use the dividend discount model formula:

Price = Dividend / (Rate of return - Dividend growth rate)

We know that Fred wants a 10% rate of return, so the rate of return in this case is 0.10. We also know that the dividend is $1 a year, so the dividend growth rate can be calculated as:

Dividend growth rate = Dividend / Current price

Dividend growth rate = 1 / 20 = 0.05

Now we can plug in the values:

Price = 1 / (0.10 - 0.05) = $20

This means that if the price of the stock remains at $20, Fred will earn a rate of return of 5% instead of the desired 10%. To achieve a rate of return of 10%, the price of the stock needs to increase. The only choice that reflects an increase is C) increase by 5%. Therefore, the correct answer is C).

Fred Flintlock Wants to Earn a Total of 10% on His