Question

Suppose you bought today one share of XYZ Company, a fairly priced stock, that just paid $0.27 of dividend per share. Assume the dividend is expected to grow at a constant rate of 5% starting next year and the stock price is expected to be $52.50 at the end of next year. What would be your rate of return on this investment?

Answer #1

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As per Gordon Growth Model of Stock Valuation:

P=Do(1+g)/(Re-g)

P= price of share.

Do= most recent dividend

g= Growth rate

Re= required rate of return.

P=Do(1+g)/(Re-g)

Image: Refer Image.

After Referring Image:

Buying price (bp) = 50

Price after 1 year (sp) = 52.50

Dividend next year (D1)= 0.27*1.05 = 0.2835

Return on investment = (sp+d1-bp)/bp

= 5.567%

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