Question

The Beta coefficient of Norco, inc. is 2.0. the 20-year Treasury yield is 3.5% and investors currently require 8% to invest in the market as risk premium. a.

What is the required return on Norco, Inc common stock?

b. Norco has a dividend yield of 10%. Use the Dividend Discount Model to estimate the expected growth rate of the dividend.

Answer 1

a). Given, Beta is 2. risk free rate is 3.5% and market risk premium is 8%. So, using CAPM model, required return= risk free rate+Beta*(market risk premium)= 3.5%+(2*8%)= 19.5%.

b). Given dividend yield is 10%. Dividend yield is calculated as recent dividend/current share price. Using dividend discount model, P(0)= D(0)*(1+g)/(r-g). where P(0) is current stock price, r is required return and g is expected growth rate of dividend. But we have dividend yield = D(0)/P(0)= 10%. So, 10%= (r-g)/(1+g). 10%= 19.5%-g/(1+g). So, g is 8.64%.

So, expected growth rate of dividend= 8.64%