Practice Question
ABC Inc.’s next dividend is expected to be $1.75, and their dividend growth has been consistent at 7% per year. What is the stock price 5 years ago if investors require a 12% return?
Answer +
$19.86
Explanation +
Step 1: Identify Key Variables
- Next dividend \(D_1 = 1.75\)
- Growth rate \(g = 0.07\)
- Required return \(K = 0.12\)
Step 2: Calculate Current Price using DDM
\[ P_0 = \frac{D_1}{K - g} = \frac{1.75}{0.05} = 35 \]
Step 3: Discount to Find Price 5 Years Ago
\[ P_5 = \frac{P_0}{(1 + K)^5} = \frac{35}{(1.12)^5} \approx \frac{35}{1.7623} \approx 19.86 \]
Conclusion:
The stock price of ABC Inc. five years ago was approximately $19.86.