Assume a stock has just paid a $2.00-per-share dividend. Analysts believe that future dividends will grow at a 4% rate forever, and investors require an 11% return on their investment in this stock. What should the stock’s price be?
$18.18 $28.57 $29.71 $31.71
28.57
To determine the stock's price, we can use the Dividend Discount Model (DDM) formula. The DDM calculates the intrinsic value of a stock by discounting the future dividends.
To calculate the stock's price, we need to consider two factors: the current dividend and the future growth rate. Here's how to calculate it step by step:
Step 1: Calculate the current dividend per share
Given that the stock has just paid a $2.00-per-share dividend, this will be our starting point.
Step 2: Determine the future growth rate
Analysts believe that future dividends will grow at a 4% rate forever. We will use this growth rate in our calculations.
Step 3: Calculate the required rate of return
Investors require an 11% return on their investment in this stock. This is the rate at which they discount the future cash flows.
Step 4: Plug the values into the DDM formula
The DDM formula is:
Stock Price = Dividend per Share / (Required Rate of Return - Growth Rate)
Let's substitute the values into the formula:
Stock Price = $2.00 / (0.11 - 0.04)
Stock Price = $2.00 / 0.07
Stock Price = $28.57
Therefore, the stock's price should be $28.57.
The correct answer is: $28.57.