After careful analysis, you have determined that a firms dividends should grow at 2%, on average, in the foreseeable future. The firm dividend starts at $3. The required rate of return on equity is 10%. Suppose the current price of the stock is $20.56.

(a) Assuming nothing changes, what is the price of the stock in three years?

(b) Is the stock price overpriced or underpriced? Why?

(c) Suppose after three years, dividends grow at a slower rate but constant of 1.8% for ever. Would you expect an increase or decrease in the required return? Compute the new required return.

d) Suppose the Fed make an open market purchase ($50 million) and First National Bank uses all proceeds from the Fed to make more loans. Draw T-account changes to First National Bank's balance sheet in three stages i.e. 1st the purchase, 2nd the loan, 3rd after the proceeds from the loan are spent by the borrower.