USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
The National Motor Company's last dividend was $1.25, and the directors expect to maintain the historic 4 percent annual rate of growth. You plan to purchase the stock today because you feel that the growth rate will increase to 7 percent for the next three years and the stock will then reach $25.00 per share.
-Refer to Exhibit 8.2. How much should you be willing to pay for the stock if you feel that the 7 percent growth rate can be maintained indefinitely and you require a 16 percent return?
A) $11.15
B) $14.44
C) $14.86
D) $18.90
E) $19.24

Question

Quizplus · Accepted Answer

We can use the constant growth model to calculate the intrinsic value of the stock. The formula is:
Intrinsic value = (Next year's expected dividend / (Required rate of return - Expected growth rate)
First, we need to calculate the expected dividend in year 1:
Expected dividend in year 1 = $1.25 x (1 + 7%) = $1.34
Next, we can calculate the intrinsic value using a perpetual growth rate of 7%:
Intrinsic value = ($1.34 x (1 + 7%)) / (16% - 7%) = $14.86
Therefore, we should be willing to pay $14.86 per share for the stock.