Rampart Corporation has a dividend yield of 1.9%. Its equity cost of capital is 8.8%, and its dividends are expected to grow at a constant rate. a. What is the expected growth rate of Rampart's dividends? b. What is the expected growth rate of Rampart's share price?
Question
Rampart Corporation has a dividend yield of 1.9%. Its equity cost of capital is 8.8%, and its dividends are expected to grow at a constant rate. a. What is the expected growth rate of Rampart's dividends? b. What is the expected growth rate of Rampart's share price?
Solution
a. The expected growth rate of Rampart's dividends can be calculated using the Gordon Growth Model, which is a model used to determine the intrinsic value of a stock, excluding external factors such as the capital structure, the opportunity cost of capital, and the expected growth rate of dividends.
The formula for the Gordon Growth Model is:
Dividend Yield = Equity Cost of Capital - Growth Rate of Dividends
Rearranging the formula to solve for the growth rate of dividends, we get:
Growth Rate of Dividends = Equity Cost of Capital - Dividend Yield
Substituting the given values:
Growth Rate of Dividends = 8.8% - 1.9% = 6.9%
So, the expected growth rate of Rampart's dividends is 6.9%.
b. The expected growth rate of Rampart's share price is the same as the expected growth rate of its dividends. This is because, according to the Gordon Growth Model, the value of a stock is determined by its future dividends. Therefore, if the dividends are expected to grow at a constant rate, the share price is also expected to grow at the same rate.
So, the expected growth rate of Rampart's share price is also 6.9%.
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