A stock is expected to pay a year-end dividend of $2.00, i.e., D1 = $2.00. The dividend is expected to decline at a rate of 5% a year forever (g = σ5%). If the company is in equilibrium and its expected and required rate of return is 15%, which of the following statements is CORRECT?
A) the company's dividend yield 5 years from now is expected to be 10%.
B) the constant growth model cannot be used because the growth rate is negative.
C) the company's expected capital gains yield is 5%.
D) the company's expected stock price at the beginning of next year is $9.50.
E) the company's current stock price is $20.

Question

Quizplus · Accepted Answer

Note that P0 = $2/(0.15 + 0.05) = $10. That price is expected to decline by 5% each year, so P1 must be $10(0.95) = $9.50. Therefore, answer d is correct, while the others are all false.

A Stock Is Expected to Pay a Year-End Dividend of $2.00