To determine the price of the stock, we use the Gordon Growth Model (or Dividend Discount Model for a perpetuity), which is given by:

$P_0 = \frac{D_1}{r - g}$

Where:

• $P_0$ = Price of the stock today
• $D_1$ = Dividend expected next year
• $r$ = Required rate of return (16% or 0.16)
• $g$ = Dividend growth rate (2% or 0.02)

Step 1: Calculate $D_1$ (the next year's dividend)

The dividend just paid is $D_0 = 0.90$. To find $D_1$: $D_1 = D_0 \times (1 + g) = 0.90 \times (1 + 0.02) = 0.90 \times 1.02 = 0.918$

Step 2: Calculate the price using the formula

Substitute the values into the formula: $P_0 = \frac{D_1}{r - g} = \frac{0.918}{0.16 - 0.02} = \frac{0.918}{0.14} = 6.5571$

Final Answer:

$P_0 = 6.56$

The stock should be selling for 6.56.

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Would you like a breakdown of any step? Let me know! Here are some related questions to consider:

1. What would the stock price be if the growth rate increased to 3%?
2. How would the stock price change if the required return decreased to 14%?
3. What is the dividend yield for this stock?
4. What is the expected capital gains yield for this stock?
5. How does the Gordon Growth Model change if dividends grow at a variable rate?

Tip: Always ensure that the required return is greater than the growth rate for the formula to work!