Question

Stock Values The next dividend payment by ECY, Inc., will be $2.90 per share. The dividends are anticipated to maintain a growth rate of 5.5 percent, forever. If the stock currently sells for $53.10 per share, what is the required return?

Answer 1

Solution:

As per the Gordon growth model, the price of a stock can be calculated using the following formula :

P = D₁ / ( K_e – g )

Where,

P= Price of the stock

D₁ = Next dividend payment

K_e = Required Return

g = growth rate

As per the information given in the question we have

P = $ 53.10     ;   D₁ = $ 2.90   ;    g = 5.5 % = 0.0550   ; K_e = to find

Applying the above values in the formula we have

53.10 = 2.90 / (K_e – 0.0550 )

(K_e – 0.0550 )= 2.90 / 53.10

(K_e – 0.0550 ) = 0.0546

K_e = 0.0550 + 0.0546 = 0.1096

Thus K_e = 10.96 %

Thus the required rate of return of ECY, Inc., is = 10.96 %