Later on today,you will receive an annual dividend of $2.50 a share on ABC stock.The dividend is expected to increase by 2 percent annually thereafter.Which formula should be used to compute the value of the stock today if the discount rate is 14 percent?

Question

Quizplus · Accepted Answer

The formula for computing the present value of a perpetuity (a constant stream of cash flows that continues indefinitely) is:

PV = C / r

Where PV is the present value, C is the cash flow per period, and r is the discount rate.

In this case, we have a perpetuity starting with a cash flow of $2.50 that grows at a constant rate of 2% annually. To account for the growth rate, we can use the Gordon growth model:

PV = C / (r - g)

Where g is the growth rate.

Plugging in the values from the problem, we get:

PV = $2.50 / (0.14 - 0.02)
PV = $2.50 / 0.12
PV = $20.83

However, we also need to add the present value of the first dividend payment, which is $2.50 / 1.14 (to discount it back one year at 14%). So the total present value of the stock is:

PV = $20.83 + ($2.50 / 1.14)
PV = $22.06

Answer: D

Later on Today,you Will Receive an Annual Dividend of $2