Question

The ABC Company, whose common stock is currently selling for $52 per share, is expected to pay a $3.25 dividend in the coming year. If investors believe that the expected rate of return on XYZ is 12 percent, what growth rate in dividends must be expected?

Answer 1

Using the Gordon Growth Model, the expected growth rate in dividends for ABC Company's stock to be correctly priced at $52, given a 12% required rate of return, is calculated to be 5.75%.

Step-by-step explanation:

The question revolves around finding the expected growth rate in dividends of the ABC Company's common stock. To do this, we will use the Gordon Growth Model, also known as the Dividend Discount Model (DDM), which is represented by the formula:
Price = Dividend per share / (Required rate of return - Dividend growth rate)
Rearranging the formula to solve for the dividend growth rate gives us:
Dividend growth rate = Required rate of return - (Dividend per share / Price)
Using the given figures:

• Price = $52
• Dividend per share = $3.25
• Required rate of return = 12% or 0.12
  We can calculate:
  Dividend growth rate = 0.12 - ($3.25 / $52)

This calculation yields:
Dividend growth rate = 0.12 - 0.0625
Dividend growth rate = 0.0575 or 5.75%
Therefore, investors must expect a 5.75% growth rate in dividends for the stock to be correctly priced at $52, given a 12% required rate of return.