Long Life Insurance Inc. just paid a dividend of $1.50, and projects supernormal growth at of 12% for the next three years. After that growth is expected to slow down to a normal 4% and go on at that rate for the foreseeable future. Similar stocks are earning a return of 10%. How much would you pay for a share of Long Live today?

Question

Quizplus · Accepted Answer

To calculate the present value of the stock, we can use the formula for the present value of a growing perpetuity:

PV = Dividend / (Discount Rate - Growth Rate)

For the first three years, the growth rate is 12%. After that, growth is expected to slow down to 4%. We can use an average growth rate for those three years, which is approximately 10.7%.

Using the given information:

Dividend = $1.50
Growth rate = 10.7%
Discount rate = 10%

PV = $1.50 / (10% - 10.7%) = $32.08

Therefore, the best choice is B as it gives the correct present value for the stock.