Question

A stock is expected to pay a year-end dividend of $2.00 twelve months from now. The dividend is expected to decline at a rate of 3% a year forever. If the company is in equilibrium and its expected and required rate of return is 17%, which of the following statements is CORRECT?

	a.	The constant growth model cannot be used because the growth rate is negative.
	b.	The company’s expected stock price at the beginning of next year is $9.50.
	c.	The company’s expected capital gains yield is 3%.
	d.	The company’s current stock price is $14.29.
	e.	The company’s expected stock price at the beginning of next year is $9.70.

Answer 1

Year-end Dividend = $2.00

Growth Rate = -3%

Required rate of return = 17%

Expected Stock price at the beg .of next year = Dividend ( 1 + Growth rate) / (Required rate of return - Growth Rate)

Expected Stock price at the beg .of next year = 2 (1 + (-0.03) ) /( 17% - -(3%) )

Expected Stock price at the beg .of next year =2*0.97 / 20%

Expected Stock price at the beg .of next year = $ 9.70

Correct Answer Is E The company’s expected stock price at the beginning of next year is $9.70

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