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14 February, 20:40

What should you pay for a stock if next year's annual dividend is forecast to be $5.25, the constant-growth rate is 2.85%, and you require a 15.5% rate of return?

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  1. 14 February, 20:46
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    Stock price = $41.50

    Explanation:

    We know,

    Stock price, Po = Dividend of next year (D1) : (Required rate of return (k) - divindend growth rate, g)

    Given,

    Dividend for the next year, D1 = $5.25

    Required rate of return, k = 15.5% = 0.155

    Constant growth rate, g = 2.85% = 0.0285

    Putting the values into the right formula, we get,

    Po = D1 : (k - g)

    or, Po = $5.25 : (0.155 - 0.0285)

    or, Po = $5.25 : 0.1265

    Therefore, Po = $41.50

    Therefore, the company's share price is stable and acceptable.
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