Question

McKenna Motors is expected to pay a $1.00 per-share dividend at the end of the year (D1 = $1.00). The stock sells for $20 per share and its required rate of return is 11 percent. The dividend is expected to grow at a constant rate, g, forever. What is the growth rate, g, for this stock?

a. 5%
b. 6%
c. 7%
d. 8%
e. 9%

Answer 1

The growth rate, g, for McKenna Motors' stock is calculated using the Gordon Growth Model. Given a stock price of $20, a $1.00 dividend, and an 11% required return rate, the growth rate is found to be 5%.

Step-by-step explanation:

The question at hand involves calculating the constant growth rate, g, for McKenna Motors' stock using the given dividend payment, stock price, and required rate of return. The Gordon Growth Model, also known as the dividend discount model (DDM), is used for this purpose, which is formulated as P = D1 / (r - g), where:

• P is the current stock price.
• D1 is the dividend payment at the end of the year.
• r is the required rate of return.
• g is the growth rate of dividends.

By rearranging the formula and solving for g, we can calculate the growth rate. Given the current stock price of $20, a dividend of $1.00, and a required return of 11%, the formula becomes $20 = $1.00 / (0.11 - g). Solving for g, we find that g is equal to 5%, which corresponds to option a.