Dynamic Industries paid a dividend of $1.65 on its common stock yesterday.The dividends of Wallace Industries are expected to grow at 9% per year indefinitely.If the risk-free rate is 3% and investors' risk premium on this stock is 8%,estimate the value of Wallace Industries stock 2 years from now.

Question

Quizplus · Accepted Answer

The value of Wallace Industries stock can be estimated using the Gordon Growth Model, which is given by the formula: P = D / (k - g), where P is the price, D is the dividend, k is the required rate of return (risk-free rate + risk premium), and g is the growth rate. Given that the dividend is $1.65, the growth rate is 9% (or 0.09), and the required rate of return is 11% (3% risk-free rate + 8% risk premium or 0.03 + 0.08 = 0.11), we first need to calculate the dividend 2 years from now, which would be D2 = D0 * (1 + g)^2 = $1.65 * (1 + 0.09)^2 = $1.65 * 1.1881 = $1.96 (approximately). Then, to find the value 2 years from now, we use the dividend that will be paid in the third year, which is D3 = D2 * (1 + g) = $1.96 * 1.09 = $2.1364, and apply the Gordon Growth Model: P2 = D3 / (k - g) = $2.1364 / (0.11 - 0.09) = $106.82 (approximately, but due to rounding and the choices provided, $106.84 is selected as the closest answer).

Dynamic Industries Paid a Dividend of $1