Question

A firm pays a $1.50 dividend at the end of year one (D1), has a stock price of $117 (P0), and a constant growth rate (g) of 10 percent.

Compute the required rate of return (K_e).

Rate of Return- ?

Indicate whether each of the following changes will increase or decrease the required rate of return (K_e). (Each question is separate from the others. That is, assume only one variable changes at a time.) No actual numbers are necessary.

Divided yield- ?

Required rate of return- ?

If the expected growth rate increases:

Required rate of return- ?

If the stock price increases:

Divided yield- ?

Required rate of return- ?

Answer 1

1st part:

as per dividend growth model:

K = D1/P0 + g

=>1.50/117 + 0.10

=>0.11282051

=>11.28%.

2nd part:

If dividend yield increases the required rate of return will increase.

If expected growth rate increases, the required return will increase and vice versa.

If stock price increases, the dividend yield will go down, the required return will also go down.