Question

You purchased 100 shares of General Motors stock at a price of $106.82 one year ago. You sold all stocks today for $106.94. During the year, the stock paid dividends of $5.88 per share. What is your holding period return?

You are considering the purchase of Crown Bakery, inc. common stock that just paid a dividend of $15.15 per share. You expect the dividend to grow at a rate of 5.34 percent per year, indefinitely. You estimate that a required rate of return of 8.35 percent, will be adequate compensation for this investment. What is the most that you would be willing to pay for the common stock if you were to purchase it today?

Answer 1

Question 1:

P0 = Purchase Price = 100 * $106.82 = $10,682

P1 = Sale Price = 100 * $106.94 = $10,694

D = Dividends paid = 100 * $5.88 = $588

Holding Period return = (P1 + D - P0) / P0

= ($10,694 + $588 - $10,682) / $10,682

= $600 / $10,682

= 0.0561692567

= 5.62%

Therefore, holding period return is 5.62%

Question 2:

D0 = Current Dividend = $15.15

g = growth rate = 5.34%

r = required rate of return = 8.35%

D1 = Expected Dividend = D0 * (1+g) = $15.15 * (1+5.34%) = $15.95901

Current Share Price = D1/ (r - g)

= $15.95901 / (8.35%-5.34%)

= $530.199668

= $530.20

The most willing to pay for common stock if purchased today is $530.20