# a) What is the price Mr. A is willing to pay for a stock that pays a dividend of $5 per share... ## Question: a) What is the price Mr. A is willing to pay for a stock that pays a dividend of$5 per share annually and will be sold at $50 after two years according to the Generalized Valuation Model? Mr. A's required rate of return is 8%. b) Explain why Ms. B is willing to pay a higher price for the same stock. c) What is the value of the above stock according to the Gordon Growth model if the dividend growth is 3%? ## Gordon Growth Model: The Gordon Growth model is a simple stock valuation model that represents a special case of the more general discounted dividend model. The Gordon model assumes that dividends grow at a constant rate indefinitely. ## Answer and Explanation: a) The price Mr.A will be willing to pay is the discounted present value of cash flows from the stock, which include$5 dividend for the next two years, plus the resale value of $50 at the end of 2 years. At a discount rate of 8%, the present value is: • {eq}\dfrac{5}{(1 + 8\%)} + \dfrac{5 + 50}{(1 + 8\%)^2} = 51.78 {/eq} Thus, the price Mr. A is willing to pay is$51.78.

b) Ms. B will be willing to pay a higher price if her required rate of return is lower.

c) According to the Gordon Growth model, the price of a stock is given by:

• price per share = next dividend / (required return - dividend growth rate)
• price per share = 5 / (8% - 3%)
• price per share = \$100 