Question

You believe that the Non-Stick Gum Factory will pay a dividend of $2 on its common stock next year. Thereafter, you expect dividends to grow at a rate of 4% a year in perpetuity. If you require a return of 16% on your investment, how much should you be prepared to pay for the stock? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Answer 1

$16.67

Step-by-step explanation:

Data provided in the question;

Dividend to be paid next year, D1 = $2

Expected growth rate of dividend, g = 4% = 0.04

Required rate of return on the investment = 16% = 0.16

Now,

Price to be paid for the stock =
`\frac{D1}{\textup{(r-g)}}`

or

Price to be paid for the stock =
`\frac{\$2}{\textup{(0.16-0.04)}}`

or

Price to be paid for the stock = $16.67