Next year, the price of a stock is expected to be $2,200 and the stock will pay a $55 dividend. The interest rate is 10%. Based on the dividend-discount model, what is the current price of this stock?

Question

Quizplus · Accepted Answer

Using the dividend-discount model, we can calculate the current price of the stock as:

Current Price = Dividend / (Interest Rate - Expected Growth Rate) + Expected Stock Price / (1 + Interest Rate)^t

Where: 
Dividend = $55 
Interest Rate = 10% 
Expected Growth Rate = (Expected Stock Price - Current Stock Price) / Current Stock Price = ($2,200 - Current Price) / Current Price 
Expected Stock Price = $2,200 
t = 1 year

Substituting the given values, we get:

Current Price = $55 / (0.1 - (2,200 - Current Price) / Current Price) + $2,200 / (1 + 0.1)^1 
Current Price = $55 / (0.1 - 2.2 + 2.2(Current Price)) + $2,000 
Current Price = $2,050

Therefore, the current price of the stock is $2,050, so the best choice is C.

Next Year, the Price of a Stock Is Expected to Be