Tarzak Inc. has earnings of $10 per share, and investors expect that the earnings per share will grow by 3 percent per year. Furthermore, the mean PE ratio of all other firms in the same industry as Tarzak is 15. Tarzak is expected to pay a dividend of $3 per share over the next four years, and an investor in Tarzak requires a return of 12 percent. The estimated stock price of Tarzak today should be ____ using the adjusted dividend discount model.

Question

Quizplus · Accepted Answer

The correct answer is A because the adjusted dividend discount model takes into account the expected growth rate of earnings per share, the required return, and the expected dividends. The formula for the adjusted dividend discount model is:Stock Price = (Dividend / (Required Return - Growth Rate)) + (Earnings per Share * (1 + Growth Rate) / (Required Return - Growth Rate))Plugging in the given values, we get:Stock Price = ($3 / (0.12 - 0.03)) + ($10 * (1 + 0.03) / (0.12 - 0.03))= $3 / 0.09 = $33.33 + $10 * 1.03 / 0.09= $33.33 + $10.61 / 0.09= $33.33 + $117.89= $151.22