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solution

You observed the following history of annual dividends paid by the stock: $10, $10.5, $12, $14, $14.5. The company has just paid its most recent dividend of $16. The stock is traded at $250 per share.

(a) Compute the average annual growth rate over last 6 years. Hint: A growth rate between year t and t + 1 is gt = Dt+1 – 1. Average annual growth rate is a simple average over Dt growth rates computed for all years. (

b) Assume that dividends are going to grow at the average rate you computed in part (a). What is required rate of return? (

c) Assume now that this historic trend in the dividend growth will only continue for 5 years, after which the growth rate will slow down by 3 percentage points (that is, growth rate will reduce from g to g – 3%). Assume also that the required rate of return is the same in part (b). What should be the current stock price?

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