The Magnificent Corporation is expected to pay a dividend of $0.85 per share every year indefinitely. If the current price of the share is $18.90, and the equity cost of capital for the company is 6.1%, what price would an investor be expected to pay per share five years into the future?

Question

Quizplus · Accepted Answer

Using the Gordon Growth Model, we can calculate the expected future price of the share as:
P(t+5) = D(t+6) / (r-g)
where
D(t+6) = expected dividend per share in Year 6 = $0.85
r = equity cost of capital = 6.1%
g = expected growth rate of dividends = 0% (since the dividends are expected to remain constant)
Substituting the values, we get:
P(t+5) = $0.85 / (0.061 - 0) = $13.93
Therefore, an investor would be expected to pay $13.93 per share five years into the future. The correct answer is B.

The Magnificent Corporation Is Expected to Pay a Dividend of $0.85