XYZ Company has expected earnings of $3.00 for next year and usually retains 40 percent for future growth. Its dividends are expected to grow at a rate of 10 percent indefinitely. If an investor has a required rate of return of 15%, what price would he be willing to pay for XYZ stock? a. $12.50 b. $25.00 c. $30.00 d. $40.00

Question

Business

Lesly Hull

7 November, 15:27

XYZ Company has expected earnings of $3.00 for next year and usually retains 40 percent for future growth. Its dividends are expected to grow at a rate of 10 percent indefinitely. If an investor has a required rate of return of 15%, what price would he be willing to pay for XYZ stock? a. $12.50 b. $25.00 c. $30.00 d. $40.00

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Answers (1)

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Kenzie Warner · Answer 1

Price of stock = $40

Explanation:

According to the dividend growth model, the price of a stock is the present value of expected dividend discounted at the required rate of return.

This is done as follows:

Price of a stock = D * (1+r) / (r-g)

D (1+g) - Dividend for next year = 100%-40% * $3 = $1.8

g - growth rate - 10%

r - required rate of return - 15%

Price of stock = 1.8 * (1.1) / (0.15-0.1)

= $40