Question

Stock Y's expected dividend and future price are forecasted as: D1=$2, and D2=$2.5 and P2= $100 at the end of year 2. Suppose the market required rate of return for the stock is 10%. The expected return for Year 1 (that is, the period of Year 0-1) is ___________% (round your answer to two decimal places without including %)

Answer 1

Answer. 7.69%

This is an example of dividend discount model, where the future stream of dividends when discounted to current period is the fair price of the share.

Mathematically,

Now, in our question, we need to calculate the value of share at year 1 P₁ and value of share at year 0 P₀.

P₀ = 1.818 + 2.066 + 82.645

P₀ = $86.529

P₁ = 2.273 + 90.909

P₁ = 93.182

Expected return = Price Change/Initial Price * 100

Expected return = (93.182 - 86.529)/86.529 * 100 = 7.69%