XYZ Inc. will pay a dividend of $4 per share tomorrow. This amounts to 100% of its earnings and is expected to remain constant forever. The market rate of return is 9%, the risk free rate is 3%, the beta of XYZ stock is 2, the standard deviation of the returns on XYZ stock is 15%, and XYZ is an all-equity firm. For simplicity, assume that dividends are declared and paid on the same day.

A) What is the price of XYZ stock now?

B) What will be the price of XYZ stock after the dividend is paid tomorrow?

C) On the day after the dividend is paid, XYZ announces that it has found a valuable investment opportunity such that it can invest 20% of its earnings in each of the subsequent years and earn a return of 30% on each such investment in perpetuity. What would be the stock price of XYZ after this announcement (assuming efficient markets)?

Answer rating: 100% (QA)

A To find the price of XYZ stock now we can use the Gordon Growth Model Dividend Discount Model sinc... View the full answer