Final answer:
To calculate the required rate of return on stock P, the Gordon Growth Model can be used, adjusting for the floatation cost. The required rate of return is computed to be 9.83%, which corresponds to answer choice (c).
Step-by-step explanation:
The student's question revolves around calculating the required rate of return on stock P, given certain financial inputs. To find the required rate of return for stock P, one can use the Gordon Growth Model (also known as the Dividend Discount Model), which is a method used in finance to determine the value of a stock based on its dividends and dividend growth rate. The formula for the Gordon Growth Model is as follows:
P = D / (r - g),
where:
- P is the current stock price.
- D is the expected annual dividend next year.
- r is the required rate of return.
- g is the growth rate of dividends.
To solve for the required rate of return (r), we rearrange the formula to:
r = (D / P) + g.
However, since the question also includes a floatation cost of 3.50%, which reduces the price that the investors are effectively paying for the stock, we must adjust the formula. The adjusted stock price taking into account floatation costs is P*(1 - flotation cost percentage), which will give us the net proceeds received by the company for each share sold. In this case, P_adj = $50 * (1 - 0.035) = $48.25.
Substituting the given values into the adjusted formula returns:
r = ($1.85 / $48.25) + 6.00%
Now, complete the calculation to find the required rate of return.
r = (1.85 / 48.25) + 0.06
r = 0.038347 + 0.06
r = 0.098347 or 9.83%
Thus, the correct answer is (c) 9.83%%.