Question

Consider the following data for a firm that has just paid $3 per share dividend which is expected to grow at a constant annual rate in the future.

Equity Beta=2
Risk-free interest rate= 5%
Expected market return= 10%
The firm’s stock is currently trading at $31.5 per share.

What per-share dividend growth rate is being expected by the market?

Answer 1

As per CAPM,

Required Return =Risk Free rate + (Market Return - Risk Free Rate ) * Beta

= 5% +(10%-5%)*2

= 15%

Current Price = Expected Dividend / ( Required Return - Growth Rate)

31.5 = Expected Dividend / ( 15%- Growth Rate)

31.5* (15%- Growth Rate) = Current Dividend * (1+ Growth rate)

4.725 - 31.5* Growth Rate = 3* (1+ Growth rate)

4.725 - 31.5* Growth Rate = 3 + 3* Growth Rate

4.725-3 = 31.5* Growth rate+3*Growth rate

1.725 = 34.5* Growth rate

Growth rate = 1.725/34.5*100

= 5%

Answer = 5.00%