Question

Reddick Enterprises' stock currently sells for $35.50 per share. The dividend is projected to increase at a constant rate of 5.50% per year. The required rate of return on the stock, rs, is 9.00%. What is the stock's expected price 3 years from today? $37.86 $38.83 $39.83 $40.85 $41.69

Answer 1

Answer:

E. $41.69

Explanation:

We know,

Value of stock ($P_{0}$) = $\frac{D_{1}}{k_{s} - g}$ [In case of constant growth model]

$D_{1}$ = Next year or expected dividend

$k_{s}$ = required rate of return

g = growth rate = 5.50%

However, as there is no information regarding expected dividend, we will use the alternative formula to calculate the stock's expected price 3 years from today.

$P_{3}$ = $P_{0}$ × $(1 + g)^{3}$

Here, current stock price, $P_{0}$ = $35.50

Therefore, $P_{3}$ = $35.50 × $(1 + 0.0550)^{3}$

$P_{3}$ = $35.50 × 1.1742

Stock's expected price 3 years from now = $41.69 (rounded to two decimal places)

Therefore, option E is the answer.