Question

Bosstown Inc. paid a dividend of $1.00 last year. The company expects to increase the dividend at a constant rate of 6% per year, indefinitely. The required return for Bosstown stock is 11.6%% and the risk-free rate is 6%. What will the price of Bosstown's stock be if the required return falls to 8%?

Answer 1

Answer:

When expected return is lowered to 8% share price is $53

Explanation:

The price of a stock =Do*(1+g)/r-g

Do is the dividend received last year of $1.00

g is the growth rate of dividend which is 6% per year

r is the required rate of return which is 8%

The price of Bosstown Inc's stock=$1.00*(1+0.06)/(0.08-0.06)

                                                        =$53

The price at 11.6% rate of return is also computed thus:

price=$1.00*(1+0.06)/(0.116-0.06)

       =$18.93

Hence by reducing expected return from 11.6% to 8% , the share price increased from $18.93 to $53,hence the higher the expected return , the lower the share price