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Duff Inc. paid a 2.53 dollar dividend today. If the dividend is expected to grow at a constant 4 percent rate and the required rate of return is 7 percent, what would you expect Duff's stock price to be 2 years from now?

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Nyctalus

Answer: 94.85

Explanation: we can compute stock price after two years by computing stock price today and multiplying it by square of growth rate.

we know that,

[tex]return\:on\:equity=\:\frac{expected\:dividend}{market\:price}+growth[/tex]

where,

expected dividend = current dividend (1+growth)

so, we can write the above equation as :-

[tex]0.07\:=\frac{2.53\left ( 1+0.04 \right )}{P_0}+0.04[/tex]

solving this equation we get:-

[tex]P_0= 87.70[/tex]

and price after two years:-

[tex]P_2=87.70\left ( 1+0.04\right)^2[/tex]

[tex]P_2=94.85[/tex]

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