An investor expects earnings from a stock to grow at a constant rate of 2% over time and the investors' rate of discount is constant at 5%.If earnings last year were $37, then the fundamental value of the stock would be

Question

Quizplus · Accepted Answer

The fundamental value of the stock can be calculated using the Gordon Growth Model (Dividend Discount Model for a perpetuity with growth), which is P = D / (r - g), where P is the price (fundamental value), D is the dividend (earnings in this case), r is the discount rate, and g is the growth rate. Given D = $37 * 1.02 (to account for next year's growth), r = 5% (0.05), and g = 2% (0.02), the calculation is P = ($37 * 1.02) / (0.05 - 0.02) = $37.74 / 0.03 = $1,258. Therefore, the correct answer is $1,258.

An Investor Expects Earnings from a Stock to Grow at a Constant