Final answer:
To calculate the expected rate of return on 'Steady as She Goes Incorporated', using the dividend growth model, you add the stable dividend growth rate of 4% to the dividend yield (dividend per share divided by current stock price). Subsequently, the expected rate of return for the stock at a current price of $25.00 and a dividend of $2.50 is 14%.
Step-by-step explanation:
Calculating Expected Rate of Return on a Stock
The student's question refers to the expected rate of return on a stock using the dividend growth model. To find this rate, also known as the cost of equity, we use the Gordon Growth Model (GGM), which is as follows:
Expected Rate of Return = (Dividend per Share / Current Stock Price) + Dividend Growth Rate
For 'Steady as She Goes Incorporated', which has a projected year-end dividend of $2.50 per share and an anticipated dividend growth rate of 4%, the current stock price is $25.00 per share. We can plug these values into the formula:
Expected Rate of Return = ($2.50 / $25.00) + 0.04
Expected Rate of Return = 0.10 + 0.04 = 0.14 or 14%
This implies if an investor buys a share of 'Steady as She Goes Incorporated' at the current price of $25.00, they can expect a rate of return of 14% on their investment, considering the dividend payments and the growth rate of those dividends over time.
In the case of Babble, Inc., to determine the price an investor might pay for a share, we would need to consider the present value of the expected dividends since the company will be disbanded. This would require discounting the future dividends back to their present value, summing them up, and then dividing by the number of shares to find the price per share an investor might be willing to pay. However, this calculation requires additional information, such as the required rate of return or discount rate from the investor's perspective.