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? ( |

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%**

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