If a stock's dividend is expected to grow at a constant rate of eight percent in the future and it has just paid a dividend of $1.25 a share, and you have an alternative investment of equal risk that will earn a 12 percent rate of return, what would you be willing to pay per share for this stock today?

Question

Quizplus · Accepted Answer

To determine the price per share, we can use the formula:

Price per share = Dividend / (Rate of return - Dividend growth rate)

We are given the dividend ($1.25) and the dividend growth rate (8%). We are also given an alternative investment with a rate of return of 12%.

Using the formula:
Price per share = 1.25 / (0.12 - 0.08) = $31.25

Therefore, we would be willing to pay $31.25 per share for this stock today. Choice A is the correct answer.

If a Stock's Dividend Is Expected to Grow at a Constant