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In: Finance

An investment that currently sells for $80 makes payments every year forever, which grow at 3%...

An investment that currently sells for $80 makes payments every year forever, which grow at 3% annually. If the next payment amount is $9, what is the annual return on this investment?

Solutions

Expert Solution

Answer - Annual Rate of Return = 14.25%

Explaination -

We can find the answer here by applying Gordon's Growth Model Formula,

P0 = D1 / Ke - G

where,

P0 = price of stock today

D1 = Next expected dividend

Ke = Cost of Equity or Return on investment

G = Growth rate

Therefore,

P0 = D1 / Ke - G

= $80 = $9 / Ke - 3%

By cross multiplying both sides we get,

= $80Ke - $2.4 = $9

= $80Ke = $9 + $2.4

= $80Ke = $11.4

= Ke = $11.4 / $80

= Ke = 0.1425 or 14.25%

jeff jeffy answered 2 years ago
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