Determine the Required Rate of Return for a Stock
What data do we have to calculate the required rate of return for the stock?
The market price of a stock is $48.96 and it just paid $5.06 dividend. The dividend is expected to grow at 3.26% forever.
Answer:
A Gordon Growth Model or Dividend Discount Model (DDM) is employed to determine the required rate of return on the stock. This model assumes that dividends grow at a constant rate, and based on the data provided, the necessary rate of return comes out to be approximately 13.8%.
To calculate the required rate of return for the stock, we'll use the Gordon Growth Model or Dividend Discount Model (DDM). This model is widely used for valuing a company's stock by assuming that dividends grow at a constant rate. The formula for required rate of return (k) is given by: D1 / P0 + g = k Where D1 is the expected annual dividend per share for the next year, P0 is the current price of the stock, and g is the growth rate of dividends. So, D1 would be $5.06*(1+0.0326) = $5.227816. Plugging these values into the formula gives: $5.227816 / $48.96 + 0.0326 The required rate of return, therefore, is approximately 0.138 or 13.8%.