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Suppose that a firm's dividends have been growing by 4% annually and this year's dividend is $10 per share.
-If investors perceive the stock to have become riskier and demand a 9% rate of return,then

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Quizplus · Accepted Answer

First, we calculate the expected growth rate of dividends:
Expected Dividend Next Year = Current Dividend x (1 + Dividend Growth Rate)
Expected Dividend Next Year = $10 x (1 + 0.04) = $10.40

Next, we can use the dividend discount model to calculate the stock price:
Stock Price = Expected Dividend Next Year / (Rate of Return - Dividend Growth Rate)
Stock Price = $10.40 / (0.09 - 0.04) = $208

Now, if investors perceive the stock to have become riskier, they will demand a higher rate of return. Using the same formula with a 9% rate of return, we get:
Stock Price = $10.40 / (0.09 - 0.04) = $208

Comparing the two stock prices ($208 and $240), we can see that the stock price falls by 20%. Therefore, the answer is B.

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