A stock pays a dividend of $3 next year and is expected to grow at 4% perpetually. If the required return is 9%, what is the stock price using Gordon Growth Model?

• A. 60
• B. 50
• C. 75
• D. 45

Answer: (A)

The main idea is the Gordon Growth Model, which values a stock as the present value of an infinite series of dividends that grow at a constant rate. The formula is P0 = D1 / (r − g), where D1 is the next dividend, r is the required return, and g is the growth rate of dividends forever.

Here, D1 is $3, the growth rate g is 4% (0.04), and the required return r is 9% (0.09). The difference r − g equals 0.05. So the price is P0 = 3 / 0.05 = $60. This setup assumes dividends grow forever at a steady rate and that the discount rate exceeds the growth rate, which it does in this case.