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Defenestration Industries plans to pay a $4.00 dividend this year and you expect that the firm's earnings are on track to grow at 5% per year for the foreseeable future.Defenestration's equity cost of capital is 13%.
-Suppose that Defenestration decides to pay a dividend of only $2 per share this year and use the remaining $2 per share to repurchase stock.If Defenestration's payout rate remains constant,then Defenestration's stock price is closest to:
A)$50.00.
B)$22.25.
C)$32.30.
D)$30.75.

Question

Quizplus · Accepted Answer

The stock price can be calculated using the Gordon Growth Model (Dividend Discount Model). With a $4 dividend and 5% growth, the price is $4 / (0.13 - 0.05) = $50. The repurchase doesn't change the valuation as the payout rate remains constant.

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