Question

Eastern electric currently pays a dividend of about $1.64 per share and sells for $27 a share.

a. if investors believe the growth rate of dividends is 3% per year, what rate of return do they expect to earn on the stock?

Answer 1

The investors should expect to 9.26% of Return.

Step-by-step explanation:

The Dividend Discount Model for Constant Growth should be used here.

DDM = Current Price = Dividend of Year 1 / (Required Return - Growth Rate)

Dividend of Year 1 = 1.64 (1.03) = 1.6892.

Re-arrange the above model for Required Return and put values:

Required Return = (1.6892 / 27) + .03 = .0926 OR 9.26%.

Thanks!