An analyst projects that a stock will pay a $2 dividend next year and that it will sell for $40 at year-end. If the required rate of return is 15%, what is the value of the stock? a) 25 b) 33.54 c) 36.52 d) 43.95 A stock paid a $2 dividend last year. An investor projects that next year’s dividend will be 10% higher and that the stock will sell for $40 at year end. The risk free rate of interest is 8%, the market return is 13% and the stock’s beta is 1.2. Determine the value of the stock. a) 35 b) 37 c) 39 d) 42
are you picking c) for #1 because it was closest? I keep getting $36.36 40=2/(0.15-g) => g=10% $40/1.10 = 36.36
C b/c 42/1.15
2/1.15+40/1.15 = 36.52
I get 36.5217 for #1 Char-Lee. The trick is to discount future dividend and stock price at required 15%. This is the price you are willing to pay in order to make that 15% return
For #2, you actually have to gross up the dividend to $2(1.10) = $2.20 and then discount this amount. Make sure you pay attention to which value they give you–this year’s dividend or next year’s.
For number 1, $42 discounted at 15%.
It seems like the logic is the same between these two questions. Can someone go more in depth about why we only use the required rate of return to discount the dividends and stock prices? I started off with the DDM and kept solving for g, etc. and it was a big mess.