A common stock pays dividends at the end of each year into perpetuity. Assume that the dividend increases by 2% each year. Using an annual effective interest rate of 5%, calculate the Macaulay duration of the stock in years

35 years

Explanation:

Data given in the question

Increase in dividend = 2%

Annual effective interest rate = 5%

So by considering the above information, the duration of the stock in years is

= 1 : (Annual effective interest rate - increase in dividend)

= 1 : (5% - 2%)

= 1 : 3%

= 33.33

Now the duration of the stock in years is

= (1 + interest rate) ^ 33.33

= (1 + 0.05) ^33.33

= 1.05^33.33

= 34.999 years i. e 35 years