One method of pricing a stock is to discount the stream of future dividends of
the stock. Suppose that a stock pays \(\$ P\) per year in dividends, and
historically, the dividend has been increased \(i \%\) per year. If you desire
an annual rate of return of \(r \%,\) this method of pricing a stock states that
the price that you should pay is the present value of an infinite stream of
payments:
$$\text { Price }=P+P \cdot \frac{1+i}{1+r}+P
\cdot\left(\frac{1+i}{1+r}\right)^{2}+P\cdot\left(\frac{1+i}{1+r}\right)^{3}+\cdots$$
The price of the stock is the sum of an infinite geometric series. Suppose
that a stock pays an annual dividend of \(\$ 4.00\), and historically, the
dividend has been increased \(3 \%\) per year. You desire an annual rate of
return of \(9 \%\). What is the most you should pay for the stock?