A stock you are interested in paid a dividend of $1 last year.The anticipated growth rate in dividends and earnings is 25% for the next 2 years before settling down to a constant 5% growth rate.The discount rate is 12%.Calculate the expected price of the stock.

Question

Quizplus · Accepted Answer

First, we need to calculate the dividends for the next 2 years based on the 25% growth rate:

Dividend in Year 1 = $1 x (1 + 25%) = $1.25
Dividend in Year 2 = $1.25 x (1 + 25%) = $1.56

Then, we need to calculate the expected price of the stock after 2 years using the constant growth rate formula:

P2 = D3 / (r - g) = $1.56 x (1 + 5%) / (12% - 5%) = $27.04

Finally, we need to discount the expected price back to the present using the discount rate:

P0 = P2 / (1 + r)^2 = $27.04 / (1 + 12%)^2 = $21.04

Therefore, the expected price of the stock is $21.04, which is answer choice C.

A Stock You Are Interested in Paid a Dividend of $1