Question

XYZ company is about to pay a dividend of $6.59 per share. The dividend is expected to grow at a rate of 16 percent annually. If the current cum-dividend stock price of XYZ is $89.01, what is the required rate of return?

Answer 1

Answer: From the Gordon growth model:

Formula: Price of share = Next Dividend / (k-g)

Where k is Required rate of return and g is growth.

Required rate of return (Re) = g + Next dividend / Current price of stock

Next dividend- Is the dividend that company has not paid yet and is about to pay or will pay.

Putting the given values in the formula, we get:

Re = .16 + (6.59/89.01)

Re = .2340366

Re = 23.40% is the answer

Note: If you consider this dividend as Current dividend then the formula will be:

Required rate of return (Re) = g + [Current dividend (1+g) / Current price of stock]