The stock of Gerlunice Company has a rate of return equal to 15.5 percent.
a. If the most recently paid dividend, D0, was $2.25, and if g remains constant at 5 percent, at what price should Gerlunice’s stock sell?
b. Suppose that the Federal Reserve increases the money supply, causing the risk-free rate to drop. The return expected for investing in Gerlunice will fall to 13.5 percent. How should this change affect the price of the stock?
c. In addition to the change in part (b), suppose that investors’ risk aversion declines; this fact, combined with the decline in rRF, causes rs for Gerlunice’s stock to fall to 12 percent. At what price would the stock sell?
d. Now suppose Gerlunice undergoes a change in management. The new group institutes policies that increase the expected constant growth rate to 6 percent. Also, the new management stabilizes sales and profits, which causes the return demanded by investors to decline to 11.6 percent. After all these changes, what is the firm’s new equilibrium price?