A common stock last paid a dividend of $1.20 and it is expected to grow at 6% for the next 5 years. If your required rate of return is 10%, what is the most you should pay today?

Question

A common stock last paid a dividend of $1.20 and it is expected to grow at 6% for the next 5 years.   If your required rate of return is 10%, what is the most you should pay today?

Quizplus · Accepted Answer

The price of the stock today can be calculated using the Gordon Growth Model (Dividend Discount Model). The formula is P = D1 / (r - g), where D1 is the dividend next year, r is the required rate of return, and g is the growth rate. The dividend next year (D1) is $1.20 * (1 + 0.06) = $1.272. Plugging into the formula gives P = $1.272 / (0.10 - 0.06) = $31.80.

A Common Stock Last Paid a Dividend of $1