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In: Finance
The common stock of GVK Ltd. is currently selling for Rs. 70 per share. Dividend per...
The common stock of GVK Ltd. is currently selling for Rs. 70 per share. Dividend per share has grown from Rs. 2 to the current level of Rs. 6 over the past ten years and this dividend growth is expected to continue in future also. What is the required rate of return of the GVK Ltd. ?
Solutions
Expert Solution
| Step 1 - Calculation of dividend growth rate in past 10 years | ||||||||
| We can use the Future value formula to calculate dividend growth rate. | ||||||||
| Future value = P x (1+g)^n | ||||||||
| Future value = 6 | ||||||||
| P = dividend paid 10 years before = 2 | ||||||||
| g = growth rate = ? | ||||||||
| n = number of years = 10 | ||||||||
| 6 = 2 x (1+g)^10 | ||||||||
| 3 = (1+g)^10 | ||||||||
| g = 0.116 | ||||||||
| Dividend growth rate = 11.6% | ||||||||
| Step 2 - Calculation of the required rate of return of the GVK Ltd | ||||||||
| We can use the Dividend discount formula to calculate the rate of return. | ||||||||
| Current Stock price = D11 / (r - g) | ||||||||
| Current stock price = $70 | ||||||||
| Dividend payable in 11th year = Current dividend x (1+growth rate) = $6 x (1+0.116) = $6.70 | ||||||||
| r = required rate of return = ? | ||||||||
| g = dividend growth rate = 11.6% | ||||||||
| 70 = 6.70 / (r - 0.116) | ||||||||
| (r - 0.116) = 0.095714 | ||||||||
| r = 0.2117 | ||||||||
| Required rate of return of the GVK Ltd. = 21.17% | ||||||||
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