(Q. 15 IN B) HOW MUCH SHOULD YOU PAY NOW FOR A SHARE OF STOCK THAT...

20. (Q. 15 in B) How much should you pay now for a share of stock that offers a

constant growth rate of 10 percent, requires a 16 percent rate of return, and is

expected to sell for $50 one year from now?

A) $42.00

B) $45.00

C) $45.45

D) $47.00

Answer C

The easiest way to solve this problem is to realize:

Expected rate of return = expected dividend yield + expected capital

appreciation

Also:

Expected rate of return = expected dividend yield + constant growth rate

Then:

Expected capital appreciation = constant growth rate (10%)

So:

P

1

= 110% of P

o

$50.00 = 1.1P

o

, $45.45 = P

o

.

Conceptual questions (2 points each)