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?

Question

Quizplus · Accepted Answer

To find the price per share (P), we can use the constant growth dividend discount model:

P = D / (r - g)

where D is the most recent dividend (in this case, $1.25), r is the required rate of return (in this case, 12%), and g is the expected constant growth rate of the dividend (in this case, 8%).

Plugging in the numbers:

P = $1.25 / (0.12 - 0.08) = $31.25

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

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