Question

A stock just paid a dividend of $5.37 and is expected to maintain a constant dividend growth rate of 4.6 percent indefinitely. If the current stock price is $77, what is the required return on the stock

Answer 1

The required return on the stock is 11.89%.

Step-by-step explanation:

To calculate this, the Gordon growth model (GGM) formula is used as follows:

P = d1 / (r – g) ……………………………………… (1)

Where;

P = current share price = $77

d1 = next dividend = Recent dividend * (1 + g) = $5.37 * (1 + 0.046) = $5.61702

r = required return = ?

g = dividend constant growth forever = 4.6%, or 0.046

Substituting the values into equation 1) and solve for r, we have:

77 = 5.61702 / (r - 0.046)

77(r - 0.046) = 5.61702

77r - 3.542 = 5.61702

77r = 5.61702 + 3.542

r = 9.15902 / 77

r = 0.1189, or 11.89%

Therefore, the required return on the stock is 11.89%.