Question

Storico Co. just paid a dividend of $3.15 per share. The company will increase its dividend by 20 percent next year and then reduce its dividend growth rate by 5 percentage points per year until it reaches the industry average of 5 percent dividend growth, after which the company will keep a constant growth rate forever. If the stock price is $54.50, what required return must investors be demanding on the company's stock? (Hint: Set up the valuation formula with all the relevant cash flows, and use trial and error to find the unknown rate of return.) (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

what is required return?

Answer 1

Given

Current Dividend D0=$3.15

Growth rate for first year Dividend G1=20%

Growth rate for Second year Dividend G2=20%-5%=15%

Growth rate for third year Dividend G3=15%-5%=10%

Growth rate for fourth year Dividend G4=10%-5%=5%

Dividend for first year D1=D0*(1+G1)=3.15*(1+20%)=$3.78

Dividend for Second year D2=D1*(1+G2)=3.78*(1+15%)=$4.35

Dividend for third year D3=D2*(1+G3)=4.35*(1+10%)=$4.78

Dividend for fourth year D4=D3*(1+G4)=4.78*(1+5%)=$5.02

Current Stock price S=$54.50

Let r be the rate of return

S=D1/(1+r)+D2/(1+r)^2+D3/(1+r)^3+D4/(r*(1+r)^3)

54.50=3.78/(1+r)+4.35/(1+r)^2+4.78/(1+r)^3+5.02/(r*(1+r)^3)

Solving for r we get r=8.90%