Sky, Inc. normally pays a quarterly dividend. The last such dividend paid was $2.50, all future quarterly dividends are expected to grow at 4 percent, and the firm faces a required rate of return on equity of 16.5 percent. If the firm just announced that the next dividend will be an extraordinary dividend of $10.00 per share that is not expected to affect any other future dividends, what should the stock price be?

Question

Quizplus · Accepted Answer

To calculate the stock price, we need to use the dividend discount model:

P = (D / (r - g))

where:
P = stock price
D = expected dividend
r = required rate of return
g = expected dividend growth rate

Using the information given in the question:

For the next dividend: D = $10.00

For future dividends: D1 = D * (1 + g) = $2.50 * (1 + 0.04) = $2.60

g = 0.04
r = 0.165

Therefore:

P = (10 / (0.165 - 0.04)) + 2.60 /(0.165 - 0.04)) = $27.17

So the stock price should be $27.17. Therefore, the correct choice is D.

Sky, Inc Normally Pays a Quarterly Dividend