Consider a firm that had been priced using a 12 percent growth rate and a 16 percent required return. The firm recently paid a $5.00 dividend. The firm has just announced that because of a new joint venture, it will likely grow at a 12.5 percent rate. How much should the stock price change (in dollars and percentage)?

Question

Quizplus · Accepted Answer

Using the dividend discount model, we can calculate the original stock price:
P = D/(r-g) = 5/(0.16-0.12) = $62.50
Then, with the new expected growth rate:
P' = D*(1+g)/(r-g) = 5.625/(0.16-0.125) = $83.21
The stock price should change by: 
$83.21 - $62.50 = $20.71, which is a percentage increase of: 
($20.71/$62.50) x 100% = 33.14%
But the question asks for the change in percentage points, so we need to subtract the original growth rate from the new growth rate:
12.5% - 12% = 0.5%
Therefore, the stock price should change by $20.71 or 14.79%. The correct answer is C.

Consider a Firm That Had Been Priced Using a 12