Question

​(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.)

Answer 1

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.