Discuss the effects on the current price of a stock from each of the following:a) An increase in the growth rate of the dividend;b) A decrease in the risk-free interest rate;c) An increase in the equity-risk premium; and finallyd) A decrease in the annual dividend.
What will be an ideal response?
We can use the dividend-discount model to think through our answers:
Ptoday = 
where Dtoday is the current dividend; rf is the risk-free rate; rp is the risk premium; g is growth rate of the dividend; we are measuring the impact on Ptoday. From the formula we see that an increase in g will cause Ptoday to increase. In addition, a decrease in rf will also cause Ptoday to increase. An increase in rp on the other hand will reduce Ptoday as will a decrease in the annual dividend.
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