Question

Consider a firm that had been priced using a 12 percent growth rate and a 14 percent required return. The firm recently paid a $1.45 dividend. The firm just announced that because of a new joint venture, it will likely grow at a 12.5 percent rate.

How much should the stock price change (in dollars and percentage)? (Round your answers to 2 decimal places.)

Answer 1

Po - Divi -9 Po = Price of Stock Divi = Estimated Dividends for Next Period r = Required Rate of Return 9 = Growth Rate

a) g = 12%

Div1 = $1.45 * (1 + 12%) = $1.624

$P_0 = \frac{1.624}{0.14 - 0.12}$

$P_0 = 81.20$

b) g = 12.5%

Div1 = $1.45 * (1 + 12.5%) = $1.63125

$P_0 = \frac{1.63125}{0.14 - 0.125}$

$P_0 = 108.75$

Change in Stock Prices = $108.75 - $81.20 = $27.55

Percentage Change = $27.55/$81.20 = 33.93%