The Pancake House pays a constant annual dividend of $1.25 per share.How much are you willing to pay for one share if you require a 15 per cent rate of return?

Question

Quizplus · Accepted Answer

The price that an investor is willing to pay for a share of a company is calculated using the dividend discount model (DDM). Here, the DDM formula can be written as follows:

Price of stock = Dividend / (Rate of return - Dividend growth rate)

Here, the dividend is $1.25, and the dividend growth rate can be assumed to be zero since the problem indicates that the dividend payout is constant. The required rate of return is given as 15% or 0.15. Plugging these values into the formula, we get:

Price of stock = $1.25 / (0.15 - 0)
Price of stock = $8.33

Therefore, an investor should be willing to pay $8.33 for one share of The Pancake House, and the best choice is C.

The Pancake House Pays a Constant Annual Dividend of $1