How much should you pay for a share of stock that offers a constant growth rate of 10 percent, requires a 16 percent rate of return, and is expected to sell for $50 one year from now?
A)$42.00
B)$45.00
C)$45.45
D)$47.00

Question

Quizplus · Accepted Answer

The formula for the constant growth rate model is: 
P = D1 / (r-g)

where P is the current price of the stock, D1 is the expected dividend one year from now, r is the required rate of return, and g is the constant growth rate.

In this case, we know that D1 (the expected dividend one year from now) is not given, so we cannot use this formula directly. However, we do know that the stock is expected to sell for $50 one year from now, so we can use this information to calculate D1:

D1 = $50 x 10% = $5.

Now we can use the formula:

P = $5 / (0.16 - 0.10) = $45.45

Therefore, the best choice is C, which is $45.45.

How Much Should You Pay for a Share of Stock