Consider a firm that had been priced using a 10 percent constant growth rate and

Question

Consider a firm that had been priced using a 10 percent constant growth rate and a 14 percent required rate. The firm recently paid a $1.00 dividend. The firm has just announced that because of a new joint venture, it will likely change the growth rate to 12 percent constant growth rate. How much should the stock price change (in dollars and percentage)? Hint: First calculate the values of the stock with old and new g and compare their values to calculate the percentage change. a. $25, 1% b. $25, 100% c. $28.50, 1.04% d. $28.50, 104% e. $25, 104%

Explanation / Answer

Old stock price=Dividend for next period/(Required return-Growth rate)

=(1*1.1)/(0.14-0.1)=$27.5

New stock price=(1*1.12)/(0.14-0.02)=$56

Hence dollar chang(56-27.5)=$28.5

Hence % change=(28.5/27.5)=104%(Apprxo)

Hence the correct option is D.

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