Question

A) The preferred stock of Zizi Inc. pays a $1.50 dividend. What is the value of the stock if your required rate of return is 7 percent?

b) Madrigal Inc. paid a $2 last year, and the stock is currently selling for $87. If investors require a 10% return on their investment from buying Madrigal stock, what growth rate would Madrigal have to provide the investors?

Answer 1

The value of Zizi Inc.'s preferred stock with a $1.50 dividend at a 7% required return is $21.43. For Madrigal Inc.'s stock to provide a 10% return at its current price of $87 with a $2 dividend, it would require a 7.7% growth rate.

Step-by-step explanation:

The value of Zizi Inc.'s preferred stock, which pays a $1.50 dividend, can be calculated by dividing the dividend by the required rate of return.

Thus, if the required rate of return is 7 percent, the value of the stock would be calculated as $1.50 / 0.07, which equals approximately $21.43.

For Madrigal Inc., given that the dividend last year was $2 and the stock is currently selling for $87, the growth rate that Madrigal would need to provide for investors seeking a 10% return can be calculated using the formula for the Gordon Growth Model: P = D / (r - g), where P is the current stock price, D is the dividend, r is the required rate of return, and g is the growth rate.

Rearranging to solve for g, we get g = r - (D / P).

Substituting the given values, g = 0.10 - ($2 / $87), which is approximately 7.7% growth rate required.