(Common stock valuation) The common stock of NCP paid $ 1.45 in dividends last year. Dividends are expected to grow at an annual rate of 5.50 percent for an indefinite number of years. a. If NCP's current market price is $ 27.23 per share, what is the stock's expected rate of return? b. If your required rate of return is 7.5 percent, what is the value of the stock for you? c. Should you make the investment? (Round to two decimal places.)
1.The expected rate of return is calculated using the dividend discount model. It is calculated using the below formula:
Ke=D1/Po+g
where:
D1= Next year’s dividend
Po=Current stock price
g=Firm’s growth rate
Ke = $1.45*(1 + 0.0550) / $27.23 + 0.0550
= $1.5298 / $27.23 + 0.0550
= 0.0562 + 0.0550
= 0.1112*100
= 11.12%.
b.Value of the stock =D1/(r-g)
where:
D1=next dividend payment
r=interest rate
g=firm’s expected growth rate
Value of the stock today= $1.5298 / 0.075 - 0.055
= $1.5298 / 0.020
= $76.49.
c.The expected rate of return exceeds the required rate of return, therefore, the value of the security is greater than the current market price. Thus, I should buy the stock.
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