Question

sonic is currenSonic is currently selling for $24.38 and pays annual dividends of $0.56 per share. Suppose investors expect dividends to grow at a constant rate of 6% per year, forever. Assuming markets are efficient, what is the required return on SONC?

Answer 1

Answer:

8%

Explanation:

This is calculated by using the Gordon growth model (GGM) formula which has the assumption that

dividend growth rate will be stable year after year forever. The formula is as follows:

P = d/(r – g) ……………………………………… (1)

Where;

P = current share price = $24.38

d = next year dividend = 0.56*1.06 = 0.5936

r = required return = ?

g = dividend constant growth forever = 6%, or 0.06

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

24.38 = 0.5936/(r – 0.06)

24.38(r – 0.06) = 0.5936

24.38r – 1.4628 = 0.5936

24.38r = 0.5936 + 1.4628

r = 2.0564/24.38

r = 0.08, or 8%

Therefore, the required return on SONC is 8%.

Answer 2

Based on the information given the required return on SONC is 8.43%.

Using this formula

P = d/(r – g)  

Where;

Current share price=P= $24.38

Dividend =d=[0.56×(1+.06)] = 0.5936

Required return = r=?

Constant growth forever=g = 6% or 0.06

Let plug in the formula by solving for r

24.38=[0.56×(1+.06)]/(r-.06)

24.38=(0.56×1.06)/(r-.06)

24.38 = 0.5936/(r – .06)

24.38(r – 0.06) = 0.5936

24.38r – 1.4628 = 0.5936

24.38r = 0.5936 + 1.4628

24.38r =2.0564

Divide both side by 24.38

r = 2.0564/24.38

r = 0.0843×100

r=8.43%

Inconclusion the required return on SONC is 8.43%.

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