Expected Dividend Growth Rate, Dividend, Required Rate of Return, Stock Price, Trading, CFA Level 1, Test Prep

Expected Dividend Growth Rate

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Question

A stock has an expected dividend growth rate of 4.9%. The firm has just paid a dividend of $2.5 per share. With a required rate of return of 10%, the stock is trading at $42.8. The stock is:

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A. B. C. D.

D

The fair price of the stock with a required rate of return, r and a dividend growth rate, g, is given by P = D1/(r-g), where D1 = Do*(1-g) = dividend to be paid next year. In this case, the fair price of the stock equals 2.5*1.049/(10% - 4.9%) = $51.42. Thus, the stock is under-priced by $(51.42 - 42.8) = $8.62.

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