Question #113
Reading: Reading 20 Discounted Dividend Valuation
PDF File: Reading 20 Discounted Dividend Valuation.pdf
Page: 45
Status: Unattempted
Question
Suppose the equity required rate of return is 10%, the dividend just paid is $1.00 and dividends are expected to grow at an annual rate of 6% forever. What is the expected price at the end of year 2?
Answer Choices:
A. $29.78
B. $28.09
C. $27.07
Explanation
The terminal value is $29.78, and that is the price an investor should be willing to pay at
the end of year 2. The correct answer is shown below.
Year
Dividend
1
$1.0600
2
$1.1236
3
$1.1910
V2: $1.191/(0.10 – 0.06) = $29.78
(Module 20.2, LOS 20.c)
V0 =
+
+
V0 = 30.60
1.20
1.085
1.44
(1.085)2
1.04(1.44)
(0.085−0.04)(1.085)2