If a stock's dividend is expected to grow at a constant rate of 8 per cent in the future and it has just paid a dividend of $1.25 a share,and you have an alternative investment of equal risk that will earn a 12 per cent rate of return,what would you be willing to pay per share for this stock?

Question

Quizplus · Accepted Answer

To calculate the present value of the stock, we can use the formula P = D/(r-g), where P is the present value, D is the most recent dividend, r is the required rate of return, and g is the growth rate of dividends.

In this case, D = $1.25, g = 8%, and the required rate of return, r, is 12%.

P = $1.25/(0.12 - 0.08) = $1.25/0.04 = $31.25.

Therefore, you would be willing to pay $31.25 per share for this stock, assuming it has equal risk to the alternative investment earning a 12% rate of return.

If a Stock's Dividend Is Expected to Grow at a Constant