Mercier Corporation’s stock is selling for $95. It has just paid a dividend of $5 a share. The expected growth rate in dividends is 8 percent.
a. What is the required rate of return on this stock?
b. Using your answer to Part a, suppose Mercier announces developments which should lead to dividend increases of 10-percent annually. What will be the new value of Mercier stock?
c. Again using your answer to Part a, suppose developments occur that leave investors expecting that dividends will not change from their current levels into the foreseeable future. Now what will be the value of Mercier stock?
d. From your answers to Parts b and c, how important are investors’ expectations of future dividend growth to the current stock price?