just paid a dividend of $2 per share. The firm’s dividend is expected to grow at
ID: 2662535 • Letter: J
Question
just paid a dividend of $2 pershare. The firm’s dividend is
expected to grow at a constant rate of 5% per year, and investorsrequire a 15
% rate of return on the stock.
What is thestock’s value?
Suppose theriskiness of the stock decreases, which
causes the required rate of return to fall to 13%. Underthose conditions, what would be the stock’svalue?
What is thestock’s value?
Suppose theriskiness of the stock decreases, which
causes the required rate of return to fall to 13%. Underthose conditions, what would be the stock’svalue?
Explanation / Answer
Price of stock P0 = D0*(1+g)/(Ks-g) = 2*(1+5%)/(15%-5%) =2*1.05/10% = $21
So Stock value is $21 b. When Ks reduces to 13%,
Price of stock P0 = D0*(1+g)/(Ks-g) =2*(1+5%)/(13%-5%) = 2*1.05/8% = $26.25 So when risk reduces, Stock priceincreases
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