Question

Your company is expected to maintain a constant 4 per cent growth rate in its dividends indefinitely. You have just received a dividend of £2 per share. The shares that you own trade currently for £50/share. What is the required rate of return?

Answer 1

To calculate the required rate of return with a constant dividend growth rate, the Gordon Growth Model is used. For a £2 dividend per share and a share price of £50 with a 4% growth rate, the required rate of return would be 8%.

Step-by-step explanation:

The question requires calculating the required rate of return for a stock when the company is expected to maintain a constant 4 percent growth rate in dividends indefinitely. Given a dividend of £2 per share, and a current trading price of £50 per share, one can use the Gordon Growth Model (also known as the Dividend Discount Model). The formula for the model is:

Required Rate of Return = (Dividend per Share / Current Stock Price) + Dividend Growth Rate

Substituting the given values:

Required Rate of Return = (£2 / £50) + 0.04 = 0.04 + 0.04 = 0.08 or 8%

This means that an investor would require an 8% rate of return on this investment to accommodate both the dividends and the growth in dividends.