Wallace Industries paid a dividend of $1.65 on its common stock yesterday.The dividends of Wallace Industries are expected to grow at 9% per year indefinitely.If the risk free rate is 3% and investors' risk premium on this stock is 8%,estimate the value of Wallace Industries stock 2 years from now.

Question

Quizplus · Accepted Answer

The value of the stock can be estimated using the Gordon Growth Model (Dividend Discount Model). The formula is P = D1 / (r - g), where D1 is the dividend expected next year, r is the required rate of return, and g is the growth rate. The required rate of return is the risk-free rate plus the risk premium (3% + 8% = 11%). The dividend expected in 2 years is D0 * (1 + g)^2 = $1.65 * (1.09)^2 = $1.962. The stock price 2 years from now is P2 = D3 / (r - g) = $1.962 * (1.09) / (0.11 - 0.09) = $106.84.

Wallace Industries Paid a Dividend of $1