A stock has a current annual dividend of $6.00 per year and it is expected to grow by 3% (0.03) a year.It is expected that two years from now the stock will sell for $90.00 a share.If the interest rate is 5% (0.05), then equation 7 in the chapter predicts the stock's current price should be:

Question

Quizplus · Accepted Answer

Using the dividend discount model equation:

Current price = (dividend next year) / (discount rate - dividend growth rate)

Let's first find the expected dividend two years from now:

Expected dividend in two years = $6.00 * (1 + 0.03)^2 = $6.42

Now we can calculate the current price:

Current price = [$6.42 / (0.05 - 0.03)] / (1 + 0.05)^2 = $93.12

Therefore, the best choice is B, $93.12.

A Stock Has a Current Annual Dividend of $6