A stock is expected to pay a dividend of $2.75 at the end of the year (i. e., D1 = $2.75), and it should continue to grow at a constant rate of 5% a year. If its required return is 13%, what is the stock's expected price 2 years from today? Do not round intermediate calculations. Round your answer to the nearest cent.

Question

Business

Phoenix Clark

13 April, 03:08

A stock is expected to pay a dividend of $2.75 at the end of the year (i. e., D1 = $2.75), and it should continue to grow at a constant rate of 5% a year. If its required return is 13%, what is the stock's expected price 2 years from today? Do not round intermediate calculations. Round your answer to the nearest cent.

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Steve Oneal · Answer 1

43.89.

Explanation:

Firstly, we need to calulate the stock intrinsic value as of now using dividend discounted model (DDM). The dividend discounted model is stated as below:

Stock intrinsic value = Next year dividend / (Required rate of return - Dividend long term growth)

= 2.75 / (13% - 5%) = 34.375.

This a perfectly efficient market, the stock will grow 15% each each from now. So expected value of the stock in 2 years is 34.375 x (1 + 13%) ^2 = 43.89.