Supernormal growth: 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 5.00 percent per year. What is should the current price of the firm's stock (P0) be today if investors require a rate of return of 12.00 percent on the stock? (Round off to the nearest $0.01)

Question

Quizplus · Accepted Answer

We can use the dividend discount model to calculate the current price of the stock as follows: P0 = (D₁ / (1 + r)1) + (D₂ / (1 + r)2) + (D₃ / (1 + r)3) + (D3 * (1 + g) / (r - g)) where r is the required rate of return, g is the expected growth rate of dividends after three years, and D3 is the expected dividend in year 3. Plugging in the given values, we get: P0 = (1.10 / 1.12) + (1.20 / 1.122) + (1.30 / 1.123) + (1.30 * 1.05 / (0.12 - 0.05)) = $16.74 Therefore, the current price of the stock should be $16.74, so the best choice is C.

Supernormal Growth: Suppose a Firm's Expected Dividends for the Next