Ace the Business Degree Certification Test 2025 – Unleash Your Inner CEO!

Question: 1 / 400

What is the maximum amount you should pay for a share of stock with a dividend of $1.75 that decreases by 1.5% annually, given a required rate of return of 14%?

$11.29

To determine the maximum amount you should be willing to pay for a share of stock with a declining dividend, one must use the formula for the present value of a perpetuity that is expected to decline. The formula for a perpetuity that decreases at a constant rate can be expressed as:

\[ P = \frac{D}{r - g} \]

Where:

- \( P \) is the price of the stock,

- \( D \) is the dividend in the first year,

- \( r \) is the required rate of return,

- \( g \) is the growth rate of the dividend (which, in this case, is negative due to the decline).

Here, the annual dividend is $1.75, the required rate of return is 14% (or 0.14), and the dividend is decreasing by 1.5% annually, which means \( g = -0.015 \).

Plugging the values into the formula, we have:

\[ P = \frac{1.75}{0.14 - (-0.015)} \]

\[ P = \frac{1.75}{0.14 + 0.015} \]

\[ P = \frac{1.75}{

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$12.64

$13.27

$14.00

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