Suppose a firm's expected dividends for the next three years are as follows: D₁ = $1.10, D₂ = $1.20, and D₃ = $1.30. After three years, the firm's dividends are expected to grow at 5 percent per year. What should the current price of the firm's stock (P₀) be today if investors require a rate of return of 12 percent on the stock? (Do not round intermediate calculations. Round off final answer to the nearest $0.01) A) $61.30 B) $10.10 C) $16.74 D) $24.12

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Quizplus · Accepted Answer

Using the Gordon growth model, we can calculate the current price of the stock as: P₀ = (D₁ / (1+k)^1) + (D₂ / (1+k)^2) + (D₃ / (1+k)^3) + (P3 / (1+k)^3) where k is the required rate of return, P3 is the expected stock price after three years, and we are given that the dividends will grow at 5% per year after 3 years. Substituting the given values, we get: P₀ = (1.10 / (1+0.12)^1) + (1.20 / (1+0.12)^2) + (1.30 / (1+0.12)^3) + ( (1.30*(1+0.05)) / (0.12-0.05)/(1+0.12)^3 ) P₀ = $16.74 (rounded to the nearest $0.01) Therefore, the best choice is C, $16.74.

Suppose a Firm's Expected Dividends for the Next Three Years