Question

ABC expects to pay a dividend one year from now of $2.73. The dividend exhibits constant growth of 7.9%, and the current price of the stock is $46.48. Given all of this information, what is the expected rate of return for this stock under the Discounted Cash Flow model? (Show your answer as a decimal to four places, e.g., if you got 12.34% then input 0.1234)

Answer 1

The Expected Rate of return for this stock under the Discounted Cash Flow model

Under Constant-growth dividend discount model,

Current Stock Price = D1 / (Ke – g)

Where, D1 = Dividend in Next Year

Ke = Expected Rate of Return

g = Growth Rate in Dividend

Current Stock Price = D1 / (Ke – g)

$46.48 = $2.73 / (Ke – 0.0790)

Ke – 0.0790 = $46.48 / $2.73

Ke – 0.0790 = 0.0587

Ke = 0.0587 + 0.0790

Ke = 0.1377

Ke = 13.77%

“Hence, the expected rate of return for this stock under the Discounted Cash Flow model would be 0.1377”