I believe that the Goodyear Bulb Company will pay a dividend of $2 on
its common stock next year. Thereafter, I expect dividends to grow at
a rate of 6 percent a year in perpetuity. If I require a return of 12
percent on my investment, how much should I be prepared to pay for the
stock?

Hello.

The formula for the present value of a growing perpetuity is:

        C
PV =  ----- 
       r-g

PV stands for "prsent value." 'C' is the first dividend payment, while
'r' is the discount rate (i.e., the expected return rate you require)
and 'g' is the growth rate.


Applying the formula to your data:

        C         $2        $2
PV =  ----- = --------- =  -----  = $33.33
       r-g    .12 - .06     .06

You should be prepared to pay up to $33.33 for the stock.


------------------
search strategy:
"growing perpetuity" "dividend next year"

There's a good explanation with "growing perpetuity" examples in this
UC Davis Economics 134 lecture:
http://www.econ.ucdavis.edu/faculty/ncetorelli/ECON134/ECN134_Lecture4.pdf


I hope this helps.

---

Clarification of Answer by juggler-ga on 27 May 2004 17:32 PDT

Sorry for that typo above:

PV stands for "present value."