Question

Holtzman Clothiers's stock currently sells for $38 a share. It just paid a dividend of $3.75 a share (i.e., D0 = $3.75). The dividend is expected to grow at a constant rate of 5% a year.

What stock price is expected 1 year from now? Round your answer to two decimal places. $ 39.9

What is the required rate of return? Round your answer to two decimal places. Do not round your intermediate calculations.

(Please show work)

Answer 1

Solution:
a.	stock price is expected 1 year from now P1	39.90
b.	Required rate of return	15.36	%
Working Notes:
	current price P0= $38
	g = constant growth rate = 5%
	D0 = $ 3.75            current dividend.
	P1 expected price 1 year from now we can get
	Using dividend growth model
	P1 = P0 x (1+g)^1
	P1= 38 x (1+.05)^1
	P1 = $39.90
	stock price is expected 1 year from now = P1 = $39.90
	r = required rate of return = ??
	Using dividend growth model
	P1 expected price 1 year from now we can get
	P1 = D2/(r - g)
	P1 = D0 x (1+g)^2 /(r - g)
	$39.90 = 3.75 (1+.05)^2 / (r - .05)
	39.90 = 4.134375/ (r - .05)
	r - 0.05 = 4.134375/ 39.90
	r= 0.103618421 + 0.05
	r = .153618421
	r = 15.36 %
	The required rate of return = 15.36%
Please feel free to ask if anything about above solution in comment section of the question.