(Q. 20 IN B) DEF CORP. HAS JUST PAID A $2 PER SHARE DIVIDEND. THE...
17. (Q. 20 in B) DEF corp. has just paid a $2 per share dividend. The dividend is projected to grow at 3% per year indefinitely. If the required rate of return on the stock is 9%, then by what percentage does P
1
exceed P0
? A) 2%B) 3% C) 5.25% D) 9% Solution B Note that (P1
– P0
) / P0
= (D2
- D1
) / D1
= g = 3%. One can also compute the prices and their relative difference: The price P0
today P0
= D1
/(r - g) = $2 × 1.03 / (0.09 - 0.03) = $2.06 / 0.06 = $34.33 per share The price P1
in one year P1
= D2
/(r - g) P1
= D2
/(r - g) = ($2.06 × 1.03) / (0.09 - 0.03) = $35.36 per share % increase = (P1
– P0
) / P0
= ($35.6 - $34.33) / $34.33 = 3%