How much should you pay for a share of stock that offers a constant growth rate of 10 percent, requires a 16 percent rate of return, and is expected to sell for $50 one year from now? A)$42.00 B)$45.00 C)$45.45 D)$47.00 The easiest way to solve this problem is to realize: Expected return = expected dividend yield + expected capital appreciation Then: )16 = .06 + expected capital appreciation )10 = expected capital appreciation And P₁ = 110% of P_o $50)00 = 1.1P_o

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Quizplus · Accepted Answer

Using the formula for expected return, we can find the expected dividend yield as: 16% = dividend yield + 10% Dividend yield = 6% Next, we can use the formula for the present value of a stock with constant growth to find the fair value: P_o = D1 / (r - g) P_o = 1.06 / (0.16 - 0.10) P_o = $45.45 Therefore, the fair value of the stock is $45.45. If it is expected to sell for $50 one year from now, then it is overvalued and not a good investment at its current price.

How Much Should You Pay for a Share of Stock