(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)