Majestic Homes' stock traditionally provides an 8% rate of return. The company just paid a $2 a year dividend which is expected to increase by 5% per year. If you are planning on buying 1,000 shares of this stock next year,how much should you expect to pay per share if the market rate of return for this type of security is 9% at the time of your purchase?

Question

Quizplus · Accepted Answer

First, we need to find the expected dividend for next year:
Expected dividend = Current dividend x (1 + growth rate) 
Expected dividend = $2 x (1 + 0.05) 
Expected dividend = $2.10

Next, we need to calculate the price of the stock using the dividend discount model:
Price = Dividend / (Rate of Return - Growth Rate) 
Price = $2.10 / (0.09 - 0.05) 
Price = $52.50

Therefore, you should expect to pay $52.50 per share for Majestic Homes' stock next year. Choice (B) is the correct answer.

Majestic Homes' Stock Traditionally Provides an 8% Rate of Return