Question

The XYZ corporation, whose common stock currently sells for $40 per share is expected to pay $2.00 in dividend per share for the coming year. Investors in XYZ corporation require a return of 14% on their investment. The growth rate of dividends expected must be:

Answer 1

g = 0.09 or 9%

Step-by-step explanation:

Using the constant growth model of dividend discount model, we can calculate the price of the stock today. The DDM values a stock based on the present value of the expected future dividends from the stock. The formula for price today under this model is,

P0 = D1 / (r - g)

Where,

• D1 is dividend expected for the next period

• g is the growth rate

• r is the required rate of return

By plugging in the available values for P0, D1 and r, we can calculate the value of g to be,

40 = 2 / (0.14 - g)

40 * (0.14 - g) = 2

5.6 - 40g = 2

5.6 - 2 = 40g

3.6 / 40 = g

g = 0.09 or 9%