A stock just paid a dividend of $4.25 and is expected to maintain a constant dividend growth rate of 4.4 percent indefinitely. If the current stock price is $72, what is the required return on the stock?
Question
A stock just paid a dividend of 72, what is the required return on the stock?
Solution
To calculate the required return on the stock, we can use the Gordon Growth Model (also known as the Dividend Discount Model). The formula is:
Required Return = (Dividend payment / Price) + Growth Rate
Here's how you can calculate it step by step:
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Identify the variables in the problem:
- Dividend payment (D1) = $4.25
- Growth rate (g) = 4.4% = 0.044 (in decimal form)
- Price (P) = $72
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Substitute the values into the formula:
Required Return = (4.25 / 72) + 0.044
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Perform the division:
Required Return = 0.059027777777777776 + 0.044
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Add the results:
Required Return = 0.10302777777777778
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Convert the decimal to a percentage:
Required Return = 10.3%
So, the required return on the stock is approximately 10.3%.
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