Church Inc.is presently enjoying relatively high growth because of a surge in the demand for its new product.Management expects earnings and dividends to grow at a rate of 22% for the next 4 years,after which competition will probably reduce the growth rate in earnings and dividends to zero,i.e. ,g = 0.The company's last dividend,D₀,was $1.25,its beta is 1.20,the market risk premium is 5.50%,and the risk-free rate is 3.00%.What is the current price of the common stock?

Question

Quizplus · Accepted Answer

The correct answer is A because the current price of the common stock is $26.57. This is calculated using the Gordon Growth Model, which is:P0 = D1 / (r - g)where:P0 is the current price of the common stockD1 is the dividend expected to be paid at the end of the next yearr is the required rate of returng is the growth rateIn this case, D1 = $1.25 * (1 + 0.22) = $1.52, r = 3.00% + 1.20 * 5.50% = 9.10%, and g = 0.22. Plugging these values into the formula, we get:P0 = $1.52 / (0.0910 - 0.22) = $26.57