Question

ABC Limited will pay a $6.51 dividend next year (t=1) on its ordinary shares. The shares are currently selling at $44.43 per share. What is the market's required return on this investment if the dividend is expected to grow at 3% forever? (as a percentage to nearest two decimal places; don't use % sign) Answer:

Answer 1

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Correct Answer: 17.65

Working :

Since the dividend is expected to grow at a constant rate forever, we will use the Gordon Growth model to find the required rate of return.

Gordon Growth Model is given by

P = D1 / ( R - G )

Here,

• P= Current Selling price of the stock
• D1= Dividend for the next year
• G = Constant growth rate
• R = Required return on the Investment

Parameters provided in the question=

• P= $ 44.43
• D1= $ 6.51
• G = 3% or 0.03
• R =?

Substituting the values in the formula.

44.43 = 6.51 / ( R - 0.03)

=>(R - 0.03) = 6.51 / 44.43

=> (R - 0.03) = 0.1465

=> R = 0.1465 + 0.03 = 0.1765 or 17.65 %

Therefore, Expected return on the Investment = 17.65 %