Question

A firm will pay a year-end dividend of $0.60, which is expected to grow at a rate of 4% indefinitely. If the current value of the firm’s shares is $24, what is the required return applicable to the investment based on the constant-growth dividend discount model (DDM)?

A. 4.25 percent
B. 4.50 percent
C. 5.25 percent
D. 6.25 percent
E. 6.50 percent

Answer 1

The required return applicable to the investment based on the constant-growth Dividend Discount Model is 6.50 percent, which is option E.

Step-by-step explanation:

The student has asked about calculating the required return for an investment using the constant-growth Dividend Discount Model (DDM). To solve for the required return (r), the DDM formula is used which is: Price = Dividend / (r - Growth). Given that the dividend (D1) is $0.60, the growth rate (g) is 4%, and the current share price (P) is $24, we can rearrange the formula to solve for r: r = (Dividend / Price) + Growth. Plugging in the given numbers: r = ($0.60 / $24) + 4%. Simplifying this, r = 2.5% + 4%, which gives us a required return of 6.5%.

Therefore, the answer is E. 6.50 percent. This is calculated by adding the expected growth rate to the dividend yield, represented by the dividend divided by the current price of the firm's shares.