Question

The common stock of Free Motion Enterprises currently sells for $29.37 a share. The stock is expected to pay an annual dividend of $1.2 per share next year. The firm has established a pattern of increasing its dividends by 4 percent annually and expects to continue doing so.

The estimated market rate of return on this stock is _______ percent.
(round answer to whole number with two decimal points: i.e., use 1.23 percent instead of 0.0123)

Answer 1

The estimated market rate of return on the stock can be calculated using the constant growth (Gordon) model:

r = (D1 / P0) + g

where r is the estimated market rate of return, D1 is the expected dividend next year, P0 is the current stock price, and g is the expected dividend growth rate.

Substituting the given values, we get:

r = ($1.2 / $29.37) + 0.04

r = 0.0409 + 0.04

r = 0.0809

Converting this to a percentage and rounding to two decimal places, we get:

r = 8.09%

Therefore, the estimated market rate of return on the stock is 8.09%.