Kermit Industries' current common stock dividend is $1.35 per share, and the dividend is expected to grow at 6% per year into the foreseeable future. Currently the risk-free rate is 4.5% and the estimated market risk premium is 8.5%. Merrill Lynch has estimated KI's beta to be 1.10. Compute the expected price for KI's common stock.
A) $17.20
B) $10.33
C) $18.23
D) $49.35

Question

Quizplus · Accepted Answer

To compute the expected price, we will use the Gordon growth model:
Expected price = (Dividend per share next year) / (Required rate of return - Dividend growth rate)
First, we need to find the dividend per share next year:
Dividend per share next year = Dividend per share * (1 + Dividend growth rate) = $1.35 * (1 + 0.06) = $1.43
Next, we need to find the required rate of return:
Required rate of return = Risk-free rate + Beta * Market risk premium = 4.5% + 1.10 * 8.5% = 13.35%
Now, we can plug in the numbers:
Expected price = $1.43 / (0.1335 - 0.06) = $18.23
Therefore, the best choice is C.

Kermit Industries' Current Common Stock Dividend Is $1