You are considering the purchase of a stock that is currently selling at $ 64 per share. You expect the stock to pay $ 4.50 in dividends next year. a.If dividends are expected to grow at a constant rate of 3 percent per year, what is your expected rate of return on this stock? b.If dividends are expected to grow at a constant rate of 5 percent per year, what is your expected rate of return on this stock?

Respuesta :

Answer:

a. Expected rate of return = 10%

b. Expected rate of return = 12%

Explanation:

Using dividend growth model we have,

[tex]P_0 = \frac{D_1}{K_e - g}[/tex]

where P[tex]_0[/tex] = Current market price

D[tex]_1[/tex] = Dividend at the year end

K[tex]_e[/tex] = Expected return

g = growth rate

Putting values in the above we have,

a. $64 = [tex]\frac{4.5}{K_e - 0.03}[/tex]

[tex]K_e - 0.03[/tex] = [tex]\frac{4.5}{64} = 0.07[/tex]

K[tex]_e[/tex] = 0.07 + 0.03 = 0.1 = 10%

b. $64 = [tex]\frac{4.5}{K_e - 0.05}[/tex]

[tex]K_e - 0.05[/tex] = [tex]\frac{4.5}{64} = 0.07[/tex]

K[tex]_e[/tex] = 0.07 + 0.05 = 0.12 = 12%

Final Answer

a. Expected rate of return = 10%

b. Expected rate of return = 12%

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