Tarzak Inc. has earnings of $10 per share, and investors expect that the earnings per share will grow by 3 percent per year. Furthermore, the mean PE ratio of all other firms in the same industryas Tarzak is 15. Tarzak is expected to pay a dividend of $3 per share over the next four years, and an investor in Tarzak requires a return of 12 percent. The estimated stock price of Tarzak today should be ____ using the adjusted dividend discount model.

Question

Quizplus · Accepted Answer

The correct answer is A because the adjusted dividend discount model takes into account the expected growth rate of earnings per share, the dividend payout ratio, and the required return. The formula for the adjusted dividend discount model is:P0 = D1 / (r - g)where:P0 is the current stock priceD1 is the expected dividend in the next yearr is the required returng is the expected growth rate of earnings per shareIn this case, the expected dividend in the next year is $3, the required return is 12%, and the expected growth rate of earnings per share is 3%. Plugging these values into the formula, we get:P0 = $3 / (0.12 - 0.03) = $116.41