A stock is expected to pay no dividends for the first three years, i.e., D1 = $0, D2 = $0, and D3 = $0. The dividend for Year 4 is expected to be $5.00 , and it is anticipated that the dividend will grow at a constant rate of 8 percent a year thereafter. The risk-free rate is 4 percent, the market risk premium is 6 percent, and the stock's beta is 1.5. Assuming the stock is fairly priced, what is the current price of the stock?
A) $ 69.31
B) $ 72.96
C) $ 79.38
D) $ 86.38
E) $100.00

Question

Quizplus · Accepted Answer

The correct answer is A because the current price of the stock is $69.31. This can be calculated using the Gordon Growth Model, which is:P0 = D4 / (r - g)where:P0 is the current price of the stockD4 is the dividend for Year 4r is the required rate of returng is the growth rate of the dividendIn this case, D4 = $5.00, r = 4% + 6% * 1.5 = 10%, and g = 8%. Plugging these values into the formula, we get:P0 = $5.00 / (10% - 8%) = $69.31

A Stock Is Expected to Pay No Dividends for the First