Question

Tell Me Why Co. is expected to maintain a constant 4.2 percent growth rate in its dividends indefinitely. If the company has a dividend yield of 6 percent, what is the required return on the company’s stock? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Required return

%

Answer 1

Solution:-

Let the Current Market Price of share (P₀) = $ 100

Dividend Yield = 6% (given)

We know Dividend Yield= Dividend /Market price of share

Now, 6%=Dividend/100

Dividend =100*6%= $6

Thus, Dividend (D₁)= $6

Growth Rate(g) = 4.20% (given)

Required return (Ke)=?

Using Dividend growth model, we have

P₀= D₁/(Ke-g)

100 = 6/(Ke-.042)

100*(Ke-.042) =6

100Ke-4.2 =6

100 Ke = 10.2

Ke = 0.102

Ke = 10.20%

Thus, required rate of return of stock is 10.20 %

Alternatively we can use direct formula:-

Required rate of return = Growth rate + Dividend Yield

                                                =6%+4.20%= 10.20%

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