Question

A firm’s stock cash dividend per share for last year was $2.78 and is expected to be $3 at the end of this year, the current stock price is $60, and the growth rate for dividends is 8 percent. Using the Gordon approach, what is the expected return?

Answer 1

13%

Step-by-step explanation:The expected return of any firm/corporation through Gordon growth model can be determined using below mentioned formula:

Expected return=d1/MV+g

In the given question

d1=expected dividend at the end of this year=$3

MV=current price of firm stock=$60

g=growth rate for dividend=8%

Expected return=$3/$60 +8%=13%

Answer 2

The expected rate of return = 13%

Step-by-step explanation:

The price of a share can be calculated using the dividend valuation model

According to this model, the value of share is equal to the sum of the present values of its future cash dividends discounted at the required rate of return.

If dividend is expected to grow at a given rate , the value of a share is calculated using the formula below:

Price=Do (1+g)/(k-g)

Where Do- Dividend now, g- growth rate, k- required rate of return(cost of equity)

This model is based on the concept of the time value of money. This concept explains that the same quantity of money receivable or payable at different points in time are the not the same. That is, one $1 Dollar of today is not the same as the same amount tomorrow because the $1 Dollar of today can be invested to earn interest therefore making worth more.

Calculating the expected rate of return

The dividend valuation model can be modified to work out the expected rate (cost of equity) where other variables are given. The formula given above is modified as follows:

Ke= (Do(1+g)/P + g) × 100

So now we can apply it to our question:

= (3/60 + 0.08) × 100

= 13%

The expected rate of return = 13%

Note that I used $3 as the dividend and not $2.78. This is because the "Do(1+g)" in the formula is to help us determine the expected dividend in year 1. But the expected dividend in year 1 has already been given to be $3 so there is no need to use the last dividend.

If the expected dividend was not given, then I would have used the the last dividend paid of $2.78 and then grow it using the growth rate.

The expected rate of return = 13%