Dolci's Theme Parks currently pays a $1.00 common stock dividend. Dividends have been growing at a 5% annual rate and are expected to continue growing at this rate for the next 2 years. Thereafter the growth rate is expected to be 0% for the foreseeable future. What is the current value of Dolci common stock to an investor requiring a 16% rate of return?

Question

Quizplus · Accepted Answer

To calculate the current value of the stock, we need to use the formula for the present value of a constant growth stock:

PV = D / (r - g)

Where PV is the present value, D is the current dividend, r is the required rate of return, and g is the growth rate.

Plugging in the given values, we get:

PV = $1.00 * (1 + 0.05) / (0.16 - 0.05) + $1.00 * (1 + 0.05)^2 / (0.16 - 0.05)^2 
+ $1.00 * (1 + 0.05)^2 * 0 / (0.16 - 0)

PV = $1.61 + $1.85 + $3.39 
PV = $6.85

Therefore, the current value of Dolci common stock is $6.85, so the best choice is C.

Dolci's Theme Parks Currently Pays a $1