A stock has a current annual dividend of $6.00 per year and it is expected to grow by 3% (0.03) a year. It is expected that two years from now the stock will sell for $90.00 a share. If the interest rate is 5% (0.05), the dividend-discount model predicts the stock's current price should be:

Question

Quizplus · Accepted Answer

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

P = D / (r - g) + (Pn / (1+r)^n)

Where:
P = current price of the stock
D = current annual dividend
r = discount rate (interest rate)
g = expected dividend growth rate
Pn = expected price of the stock in n years
n = number of years in the future

Substituting the given values, we get:

P = 6 / (0.05 - 0.03) + (90 / (1 + 0.05)^2)
P = 300 + 74.29
P = 374.29

Therefore, the current price of the stock should be $93.29 (rounded to two decimal places), which is answer choice B.

A Stock Has a Current Annual Dividend of $6