What would be the expected price of a stock when dividends are expected to grow at a 25% rate for three years, then grow at a constant rate of 5%, if the stock's required return is 13% and next year's dividend will be $4.00?

Question

Quizplus · Accepted Answer

To calculate the expected price of a stock with growing dividends, we can use the Gordon growth model:

P0 = D1 / (r - g)

Where:
P0 = current price of the stock
D1 = dividend expected next year
r = required return
g = expected dividend growth rate

First, we need to find the expected dividend for year 2 and year 3:
Year 2: D2 = D1 x (1 + g) = 4 x (1 + 0.25) = 5
Year 3: D3 = D2 x (1 + g) = 5 x (1 + 0.25) = 6.25

Then we can calculate the expected price for the stock:
P0 = [4 + 5 / (1 + 0.13) + 6.25 / (1+ 0.13)^2] / (0.13 - 0.05) = $68.62

Therefore, the best choice is C.

What Would Be the Expected Price of a Stock When