You are evaluating the purchase of Cool Toys, Inc. common stock that just paid a dividend of $1.80. You expect the dividend to grow at a rate of 12%, indefinitely. You estimate that a required rate of return of 17.5% will be adequate compensation for this investment. Assuming that your analysis is correct, what is the most that you would be willing to pay for the common stock if you were to purchase it today? Round to the nearest $.01.
A) $36.65
B) $91.23
C) $51.55
D) $74.82

Question

Quizplus · Accepted Answer

The correct answer is A. $36.65.The most that you would be willing to pay for the common stock if you were to purchase it today is $36.65. This is because the intrinsic value of the stock is $36.65, which is calculated using the dividend discount model. The dividend discount model is a valuation method that calculates the present value of a stock's future dividends. The formula for the dividend discount model is:Intrinsic Value = Dividend / (Required Rate of Return - Dividend Growth Rate)In this case, the dividend is $1.80, the required rate of return is 17.5%, and the dividend growth rate is 12%. Plugging these values into the formula, we get:Intrinsic Value = $1.80 / (0.175 - 0.12) = $36.65

You Are Evaluating the Purchase of Cool Toys, Inc