Gongoras Gorgeous Hotels currently pays a $1.80 common stock dividend. Dividends have been recently growing at a 10% annual rate and are expected to continue growing at this rate for the next 2 years. Thereafter the growth rate is expected to be 4% for the foreseeable future. What is the current value of Gongoras common stock to an investor requiring an 18% rate of return?

Question

Quizplus · Accepted Answer

To calculate the current value of Gongoras common stock, we need to find the present value of all future dividends. Using the dividend discount model, we can calculate the current value as follows:

Year 1 dividend = $1.80 * 1.10 = $1.98
Year 2 dividend = $1.98 * 1.10 = $2.18
Year 3 dividend = $2.18 * 1.04 = $2.27

Using the formula for the present value of a growing perpetuity:

PV = D / (r-g)

PV = $1.98 / (0.18 - 0.10) + $2.18 / (1 + 0.18)^2 / (0.18 - 0.10) + $2.27 / (1 + 0.18)^3 / (0.18 - 0.04)

PV = $14.86

Therefore, the current value of Gongoras common stock is $14.86, and the best choice is C.

Gongoras Gorgeous Hotels Currently Pays a $1