Majestic Homes share 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 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

Using the dividend discount model, we can calculate the expected price per share:
P = D/(r-g)
Where:
P = price per share
D = dividend per share
r = required rate of return (9%)
g = dividend growth rate (5%)

Therefore, P = €2/(0.09-0.05) = €50
However, since the dividend is expected to increase by 5% per year, we can use the formula for the future value of an annuity to find the expected price per share next year:
P = €50*(1+0.05)/(0.09-0.05) = €55.13

Therefore, the answer is C) €55.13.

Majestic Homes Share Traditionally Provides an 8% Rate of Return