Question

Majestic Homes' stock traditionally provides an 8% rate of return. The company just paid a $2 a year dividend which is expected to increase by 5% per year. If you are planning on buying 1,000 shares of this stock next year, how much should you expect to pay per share if the market rate of return for this type of security is 9% at the time of your purchase?

Answer 1

$52.5

Step-by-step explanation:

Majestic Homes' stock traditionally provides an 8% rate of return. The company just paid a $2 a year dividend which is expected to increase by 5% per year. If you are planning on buying 1,000 shares of this stock next year, you should you expect to pay $52.5 per share if the market rate of return for this type of security is 9% at the time of your purchase.

Answer 2

The intrinsic value per year would be $52.5

Step-by-step explanation:

We use the gordon model for stock valuation:

`(divends)/(return-growth) = Intrinsic \: Value`

current year dividends dividends x (1 + rgowth) = next year dividends

$2 * ( 1 + 0.05 ) = 2.10

then:

rate = 0.09

growth = 0.05

2.10/(0.09-0.05) = 52.5