Question

ten years have passed, and datamapp inc. has grown to be a very successful company that bob needs to expand. recently, bob decided to make datamaapp public in order to raise capital for expansion. datamaapp's most recent annual dividend was $1.64 per share and datamaapp stock sells for $27 per share. datamaapp as well as investors are confident the dividends will have a growth rate of 3% per year. what rate of return should be expected on datamaapp stock? (4 marks). if an investor requires a rate of return of 10%, what growth rate will datamaapp need to achieve? (3 marks). if datamaapp can have a sustainable growth rate of 5% and a plowback ratio of 0.4, what rate of return is datamaapp earning on its new investments? (4 marks) (hint: these questions use chapter 7 material).

Answer 1

Datamaapp stock is expected to yield a rate of return of approximately 10.3%, calculated using the Gordon Growth Model. To achieve the required rate of return of 10%, Datamaapp needs to sustain a growth rate of 6.7%. With a sustainable growth rate of 5% and a plowback ratio of 0.4, Datamaapp is earning a rate of return on its new investments of 8%.

Step-by-step explanation:

To determine the rate of return using the Gordon Growth Model, the formula is applied:
`\( \text{Rate of Return} = \text{Dividend Yield} + \text{Growth Rate} \)`. In this case, the dividend yield is the most recent annual dividend per share, which is $1.64, and the growth rate is 3%. Thus, the rate of return is calculated as
`\( \text{Rate of Return} = (\$1.64)/(\$27) + 0.03 \)`, resulting in approximately 0.0607 or 6.07%. To find the required growth rate for a 10% rate of return, rearrange the Gordon Growth Model
`\( \text{Growth Rate} = \text{Rate of Return} - \text{Dividend Yield} \)`. Substituting in the values,
`\( 0.10 - (\$1.64)/(\$27) \)`, results in a required growth rate of approximately 6.7%.

Lastly, to determine the rate of return on new investments with a sustainable growth rate of 5% and a plowback ratio of 0.4, the Gordon Growth Model can be adapted
`\( \text{Rate of Return} = \text{Sustainable Growth Rate} * \text{Plowback Ratio} \)`. Plugging in the values,
`\( 0.05 * 0.4 \)`, gives a rate of return on new investments of 0.02 or 2%, which, when added to the dividend yield of 3%, yields a total rate of return of 8%.