Holding D1 = 2, g = 3% and now r = 12% rather than 10%, what is the Gordon Growth price?

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Study for the Finance and Investment Challenge Test. Approaches include flashcards and multiple-choice questions with hints and explanations. Ready yourself to ace the exam!

Multiple Choice

Holding D1 = 2, g = 3% and now r = 12% rather than 10%, what is the Gordon Growth price?

Explanation:
The Gordon Growth Model values a stock as the next year's dividend divided by the required return minus the dividend growth rate. Here, D1 = 2, g = 3% (0.03), and r = 12% (0.12). Subtract the growth from the required return: 0.12 − 0.03 = 0.09. Then the price today is P0 = 2 / 0.09 ≈ 22.22. Increasing r from 10% to 12% raises the denominator (r − g) from 0.07 to 0.09, which lowers the price from about 28.57 to 22.22. This aligns with the given result. Prices move inversely with the required return when g and D1 are fixed.

The Gordon Growth Model values a stock as the next year's dividend divided by the required return minus the dividend growth rate. Here, D1 = 2, g = 3% (0.03), and r = 12% (0.12). Subtract the growth from the required return: 0.12 − 0.03 = 0.09. Then the price today is P0 = 2 / 0.09 ≈ 22.22.

Increasing r from 10% to 12% raises the denominator (r − g) from 0.07 to 0.09, which lowers the price from about 28.57 to 22.22. This aligns with the given result. Prices move inversely with the required return when g and D1 are fixed.

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