Question

P7-9: Common stock value: Constant growth McCracken Roofing Inc. common stock paid a dividend of $1.20 per share last year. The company expects earnings and dividends to grow at a rate of 5% per year for the foreseeable future. a. What required rate of return for this stock would result in a price per share of $28? b. If McCracken expects both earnings and dividends to grow at an annual rate of 10%, what required rate of return would result in a price per share of $28?

Answer 1

a) rate of return = 0.095 = 9.5%

b) rate of return = 0.147143 = 14.7143%

Step-by-step explanation:

a) using the constant growth model:

`P = (D0 (1+g))/(ke - g))`

`28=(1.2(1.05))/(ke-0.05) \\`

therefore
`ke =(1.2(1.05))/(28) +0.05`

`ke = 0.095 =9.5%`

b) using the working from above, we showed that

`ke=(Do(1+g))/(P0) + g`

given g= 10%, P0=28 and D0=1.2

`ke = (1.20(1+0.1))/(28) + 0.1 = 0.147142857 = 14.7143%`