You are considering the purchase of a Ranch\'s common stock. You expect to sell

Question

You are considering the purchase of a Ranch's common stock. You expect to sell it at the end of 1 year for $32.00. You will also receive a dividend of $2.50 at the end of the year. Ranch just paid a dividend of $2.25. If your required return on this stock is 12%, what is the most you would be willing to pay for it now?

You are considering the purchase of a Ranch's common stock. You expect to sell it at the end of 1 year for $32.00. You will also receive a dividend of $2.50 at the end of the year. Ranch just paid a dividend of $2.25. If your required return on this stock is 12%, what is the most you would be willing to pay for it now?

You are considering the purchase of a Ranch's common stock. You expect to sell it at the end of 1 year for $32.00. You will also receive a dividend of $2.50 at the end of the year. Ranch just paid a dividend of $2.25. If your required return on this stock is 12%, what is the most you would be willing to pay for it now?

Explanation / Answer

In this solution Gordon Growth Model can be applied through Gordon Growth model the price that should be payable can be ascertained, it can be computed through following formula:

Current Dividend / (Required rate of return- growth rate)

Hence first the growth rate of the dividend shall be computed, which shall be computed by using the following formulae:

{(2.50-2.25) / 2.25} x 100 = 11.11%

Hence applying the above formula we get:

2.25 / (0.12-0.1111)

2.25 / .089

= $ 25.28 is the maximum price that should be paid.

Hence appying the above formula the price can be computed in following manner:

2.25 / (0.12-0.11.11)

2.25 / (.0089)

=

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