Question

Antiques R Us is a mature manufacturing firm. The company just paid a $7 dividend, but management expects to reduce the payout by 5 percent per year indefinitely. Required : If you require an 11 percent return on this stock, what will you pay for a share today?

Answer 1

Answer:

$41.56

Explanation:

Since Antiques' dividends have a negative growth rate, we must adjust the perpetuity growth formula to recognize that negative growth:

stock price = [dividend (1 + growth rate)] / (required rate of return - growth rate)

• dividend = $7
• growth rate = -5%
• required rate of return = 11%

stock price = [$7 (1 - 5%)] / (11% - -5%) = ($7 x 95%) / 16% = $6.65 / 16% = $41.56