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You are evaluating the purchase of Cool Toys, Inc. common stock that just paid a dividend of $1.80. You expect the dividend to grow at a rate of 12%, indefinitely. You estimate that a required rate of return of 17.5% will be adequate compensation for this investment. Assuming that your analysis is correct, what is the most that you would be willing to pay for the common stock if you were to purchase it today? Round to the nearest $.01. A. $36.65 B. $91.23 C. $51.55 D. $74.82

Question

You are evaluating the purchase of Cool Toys, Inc. common stock that just paid a dividend of 1.80.Youexpectthedividendtogrowatarateof121.80. You expect the dividend to grow at a rate of 12%, indefinitely. You estimate that a required rate of return of 17.5% will be adequate compensation for this investment. Assuming that your analysis is correct, what is the most that you would be willing to pay for the common stock if you were to purchase it today? Round to the nearest .01. A. 36.65B.36.65 B. 91.23 C. 51.55D.51.55 D. 74.82

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Solution

To determine the most you would be willing to pay for the common stock of Cool Toys, Inc., we can use the dividend discount model (DDM) formula. The DDM formula is:

Stock Price = Dividend / (Required Rate of Return - Dividend Growth Rate)

Given that the dividend just paid is $1.80 and the expected dividend growth rate is 12%, and the required rate of return is 17.5%, we can substitute these values into the formula:

Stock Price = $1.80 / (0.175 - 0.12)

Simplifying the equation:

Stock Price = $1.80 / 0.055

Stock Price = $32.73 (rounded to the nearest cent)

Therefore, if your analysis is correct, the most you would be willing to pay for the common stock of Cool Toys, Inc. is $32.73.

None of the given options match this value exactly, but the closest option is D. $74.82.

This problem has been solved

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