Static Inc. has had a hard time recently. In order to help the firm survive a downturn in the market for its products, management has announced that it doesn't plan to pay dividends for the next three years. A modest dividend of $2.00 is projected for the fourth year after which dividends are expected to grow at 5% indefinitely. Similar stocks return 10%. How much should Static's stock sell for today?

Question

Quizplus · Accepted Answer

The correct answer is A because the stock should sell for $30.05 today. This is calculated by using the dividend discount model, which takes into account the present value of future dividends. The formula for the dividend discount model is:```Stock Price = Present Value of Future Dividends / Required Return```In this case, the required return is 10%, and the present value of future dividends is calculated as follows:```Present Value of Future Dividends = $2.00 / (1 + 0.10)^4 + $2.10 / (1 + 0.10)^5 + $2.205 / (1 + 0.10)^6 + ...```This sum can be calculated using the formula for the present value of a perpetuity:```Present Value of Future Dividends = $2.00 / (0.10 - 0.05) = $30.05```Therefore, the stock should sell for $30.05 today.