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Stock Valuation Explained

Gentry Can Company's latest annual dividend of $1.25 a share was paid yesterday and maintained its historic 7 percent annual rate of growth. You plan to purchase the stock today because you believe that the dividend growth rate will increase to 8 percent for the next three years and the selling price of the stock will be $40 per share at the end of that time.

a) How much should you be willing to pay for the GCC stock if you require a 12 percent return?

b) What is the maximum price you should be willing to pay for the GCC stock if you believe that the 8 percent growth rate can be maintained indefinitely and you require a 12 percent return?

c) If the 8 percent rate of growth is achieved, what will the price be at the end of Year 3, assuming the conditions in Part b?

Solution Preview

a) How much should you be willing to pay for the GCC stock if you require a 12 percent return?

What we are willing to pay is the present value of cash flows. The cash flows are the dividends and the price at the end of the period. The dividends will grow at 8% for the next three years. The dividend amounts are
Year 1 ...

Solution Summary

The solution explains how to calculate the stock price under the given conditions with step-by-step calculations.

$2.19