Question

Green Corporation (“GC”) recently paid a dividend of $1.25 per share. GC expects to grow its dividend at a current rate of 4.8% indefinitely.  GC’s common stock is currently selling for $25.50 per share and your required rate of return is 10.25%.

What is the value of one share of GC common stock to you?

What is the expected rate of return for GC’s common stock?

Should you invest in GC common stock? Explain.

Answer 1

a)Calculation of current price:
D1= 1.25*(1+0.048)= 1.31
Growth= 4.8%
Required return= 10.25%
Price= D1/(required return-growth)
= 1.31/(0.1025-0.048)= 1.31/0.0545= $24.04
Current price is $24.04
b) Calculation of expected return:
D1= 1.25*(1+0.048)= 1.31
Growth= 4.8%
Current price= $25.50
Price= D1/(required return-growth)
25.50= 1.31/(required return-0.048)
required return- 0.048= 0.0514
required return= 0.0514+0.048= 9.94
Expected return is 9.94%
c) Since the current market price(24.04) is more than the present value (25.50) so we should invest in the stock.
We should invest in the stock.