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24 April, 06:54

Bosstown Inc. paid a dividend of $1.00 last year. The company expects to increase the dividend at a constant rate of 6% per year, indefinitely. The required return for Bosstown stock is 11.6%% and the risk-free rate is 6%. What will the price of Bosstown's stock be if the required return falls to 8%?

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  1. 24 April, 07:47
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    When expected return is lowered to 8% share price is $53

    Explanation:

    The price of a stock = Do * (1+g) / r-g

    Do is the dividend received last year of $1.00

    g is the growth rate of dividend which is 6% per year

    r is the required rate of return which is 8%

    The price of Bosstown Inc's stock=$1.00 * (1+0.06) / (0.08-0.06)

    =$53

    The price at 11.6% rate of return is also computed thus:

    price=$1.00 * (1+0.06) / (0.116-0.06)

    =$18.93

    Hence by reducing expected return from 11.6% to 8%, the share price increased from $18.93 to $53, hence the higher the expected return, the lower the share price
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