On a certain date, Kastbro has a stock price of S37. 50, pays a dividend of $0.

Question

On a certain date, Kastbro has a stock price of S37. 50, pays a dividend of $0. 64, and has an equity cost of capital of 8%. An investor expects the dividend rate to increase by 6% per year in perpetuity. lie then sells all stocks that he owns in Kastbro. Given Kastbro's share price, was this a reasonable action? No, since the difference between his calculated stock price and the actual stock price most likely indicates that his estimate of dividend growth rate was incorrect. No, since the constant dividend growth rate gives a stock estimate of $37. 50. No, since the constant dividend growth rate gives a stock estimate greater than $37. 50. Yes, since the constant dividend growth rate gives a stock estimate greater than $37. 50.

Explanation / Answer

Actual worth of the stock = D1 / k-g

D1 = 0.64 x 1.06 = $0.6784, k = Cost of Capital = 8%, g = Growth Rate = 6%

Worth = 0.6784 / 0.08 - 0.06 = $33.92

So, the correct option is A.

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