A share of common stock has just paid a dividend of $2.00. If the expected long-run growth rate for this stock is 7%, and if investors require an 11% rate of return, what is the price of the stock?
To determine the price of the stock, we can use the Gordon Growth Model, also known as the dividend discount model. According to this model, the price of a stock is equal to the present value of its future dividends, discounted at the investor's required rate of return minus the long-run growth rate.
The formula for the Gordon Growth Model is:
Price of Stock = Dividend / (Required Rate of Return - Growth Rate)
In this case, the dividend just paid is $2.00, the expected long-run growth rate is 7%, and the investor's required rate of return is 11%. Let's calculate the price of the stock using these values:
Price of Stock = $2.00 / (0.11 - 0.07)
Price of Stock = $2.00 / 0.04
Price of Stock = $50.00
Therefore, the price of the stock is $50.00.