Question

If expected dividends grow at 3% and the appropriate discount rate is 5%, what is the value of a stock with an expected dividend of $2.95 ? (Round your answer to 2 decimal places.) Multiple Choice

A. $221.25
B. $147.50
C. $148.50
D. $73.75

Answer 1

Using the Gordon Growth Model, the value of a stock with a $2.95 expected dividend, a 3% growth rate, and a 5% discount rate is calculated to be $147.50, which is answer B.

Step-by-step explanation:

The value of a stock with an expected dividend that grows at 3% with a discount rate of 5% can be calculated using the Gordon Growth Model (also known as the Dividend Discount Model). This model takes the expected dividend and divides it by the difference between the discount rate and the dividend growth rate.

To calculate:

1. Subtract the dividend growth rate (3%) from the discount rate (5%), which equals 2% or 0.02 when converted to decimal form.
2. Divide the expected dividend ($2.95) by the result of step 1:

Value of Stock = $2.95 / 0.02 = $147.50

Therefore, the correct answer is B. $147.50.