Question

​(Common stockholder expected return​)

Alyward​ & Bram common stock currently sells for $23.00 per share. The​ company's executives anticipate a constant growth rate of 10.5 percent and an​ end-of-year dividend of $2.50.

a. What is your expected rate of​ return?

b. If you require a return of 17 ​percent, should you purchase the​ stock?

Answer 1

Solution :

a. The expected rate of return of a stock is calculated using the following formula:

k_e = ( D₁ / P₀ ) + g

Where

P₀ = Current Price of the share;      D₁ = End of Year dividend or next year dividend ;

g = Constant growth rate ;    k_e = Expected rate of return

As per the information given in the question we have ;

D₁ = $ 2.50 ;       g = 10.5 % = 0.105 ; P₀ = $ 23.00   ;   k_e = To find

Applying the above values in the formula we have

= ( 2.50 / 23.00 ) + 0.105

= 0.108696 + 0.105

= 0.213696

= 21.3696 %

= 21.37 % ( when rounded off to two decimal places )

Thus the expected rate of return = 21.3696 % = 21.37 %

b. Since the expected rate of return at 21.37 % is greater than the required rate of return of 17 % , the stock can be purchased.

Thus, If the required rate of return is 17 % the stock should be purchased.