Stock prices and the risk premium
Suppose a share is expected to pay a dividend of $1,000 next year, and the real value of dividend payments is expected to increase by 3% per year forever.
a. What is the current price of the stock if the real interest rate is expected to remain constant at 5%? at 8%? Now suppose that people require a risk premium to hold stocks.
b. Redo the calculations in part (a) if the required risk premium is 8%.
c. Redo the calculations in part (a) if the required risk premium is 4%.
d. What do you expect would happen to stock prices if the risk premium decreased unexpectedly? Explain in words.