Question

You’ve collected the following information from your favorite financial website.

52-Week Price Stock (Div) Div Yld % PE Ratio Close Price Net Chg
Hi Lo
64.60 47.80 Abbott 1.12 1.9 235.6 62.91 −.05
145.94 70.28 Ralph Lauren 2.50 1.8 70.9 139.71 .62
171.13 139.13 IBM 6.30 4.3 23.8 145.39 .19
91.80 71.96 Duke Energy 3.56 4.9 17.6 74.30 .84
113.19 96.20 Disney 1.68 1.7 15.5 ? .10
According to your research, the growth rate in dividends for Abbott Laboratories for the previous 5 years has been negative 11.5 percent. If investors feel this growth rate will continue, what is the required return for the company's stock? (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Answer 1

-9.92%

Step-by-step explanation:

P₀ = Div₁ / (Re - g)

• Div₁ = next year's expected dividend = $1.12 x (1 - 11.5%) = $0.9912
• Re = cost of equity = ?
• P₀ = current stock price = $62.91
• g = dividend's growth rate = -11.5%

Re = (Div₁ / P₀) + g

Re = ($0.9912 / $62.91) - 11.5%

Re = 1.58% - 11.5% = -9.92%

Since the cost of equity or required rate of return cannot be negative, I suppose that investors are not worried about Abbott distributing dividends, instead, they prefer that the company reinvests earnings in new projects.