14. How much would you pay today for a stock that offers a constant growth rate of 8% for
dividends and has an expected rate of return of 12%? You also know that the stock
should be valued at $40 one year from now?
A) $35.71
B) $37.04
C) $43.20
D) $44.80
E) $45.96
Answer B
One way to solve this problem is to realize that the growth rate for dividends (8%) is
the same as the growth rate for the value of the stock (i.e. the expected capital gain
on the stock):
P
0 = Div
1 / (r - g)
P
1 = Div
2 / (r - g) = Div
1 x (1+g)/ (r - g) = P
0 x (1+g)
Î P
0 = P
1 / (1 + g) = $40 / (1 + 8%) = $37.04
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