Question

you believe that the Non-stick Gum factory will pay a dividend of $2 on its common stock next year. Thereafter, you expect dividends to grow at the rate of 6% a year in perpetuity. If you require a return of 12% on your investment, how much should you be prepared to pay for the stock?

Answer 1

Answer:

You should pay a stock price of $33.33

Explanation:

We can use the formula below to calculate the price per share that you would be willing to pay;

RRR=(EDP/SP)+EDGR

where;

RRR-required rate of return

EDP-expected dividend payments

SP-share price

EDGR-expected dividend growth rate

This can also be written as;

Required rate of return=(Expected dividend payments/share price)+expected dividend growth rate

In our case;

RRR=12%=12/100=0.12

EDP=$2

SP=unknown

EDGR=6%=6/100=0.06

replacing;

0.12=(2/SP)+(0.06)

0.12-0.06=(2/SP)

0.06=(2/SP)

0.06 SP=2

SP=2/0.06

SP=33.33

You should pay a stock price of $33.33