Sam is evaluating a stock that is expected to pay a $1.25 per share dividend at the beginning of next year. He expects the dividend to grow by 10% per year and has determined that 12% is an appropriate required return for the stock. What is the highest amount he should pay for the stock?
A) $1.25
B) $12.50
C) $15.00
D) $62.50

Question

Quizplus · Accepted Answer

The highest amount Sam should pay for the stock is calculated using the Gordon Growth Model (Dividend Discount Model): P = D1 / (r - g), where D1 is the expected dividend ($1.25), r is the required return (12% or 0.12), and g is the growth rate (10% or 0.10). P = 1.25 / (0.12 - 0.10) = $62.50.

Sam Is Evaluating a Stock That Is Expected to Pay