A Stock pays dividends of $1.00 at t = 1. (D 1 is provided here, not D 0 ) It is

ID: 2641748 • Letter: A

Question

A Stock pays dividends of $1.00 at t = 1. (D1 is provided here, not D0) It is growing at 20% between

t =1 and t = 2, after which the growth rate drops to 10%, and will continue at that rate into the future.

If the discount rate for this stock is 15%, what should be the value of the stock at t = 0? Hint: Make a

diagram indicating ranges of the growth rates and the resulting dividends.

$23.71

$21.74

$20.00

$19.14

$24.00

A Stock pays dividends of $1.00 at t = 1. (D1 is provided here, not D0) It is growing at 20% between

t =1 and t = 2, after which the growth rate drops to 10%, and will continue at that rate into the future.

If the discount rate for this stock is 15%, what should be the value of the stock at t = 0? Hint: Make a

diagram indicating ranges of the growth rates and the resulting dividends.

$23.71

$21.74

$20.00

$19.14

$24.00

$23.71

$21.74

$20.00

$19.14

$24.00

Price = D1 / (1 + i)^1 + D2 / (1 + i)^2 + D3/ (k - g) / (1+i)^2

D1 = 1

D2 = 1 * 1.20 = 1.20

D3 = 1.20 * 1.10 = 1.32

Placing values into formula:

Price = = 1/1.15 + 1.20/1.15^2 + 1.32/(.15 - .10) / 1.15^2

= 21.74

Correct option:

$21.74

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