Answer:
The expected return is 13%.
Explanation:
Note: Before answering the question, the full question is first stated as follows:
A firm's stock cash dividend per share for last year was $2.78 and is expected to be $3 at the end of this year, the current stock price is $60, and the growth rate for dividends is 8 percent. Using the Gordon approach, what is the expected return?
The answer to the explanation of the answer is now as follows:
Gordon’s theory which is also known as ‘Bird-in-the-hand’ theory states that the importing factor to consider in determining the value of a firm are the current dividends.
Therefore, the Gordon growth model (GGM) formula which assumes that there will a stable dividend growth rate year after year forever is employed for this question as follows:
P = d1 / (r – g) ……………………………………… (1)
Where;
P = current stock price = $60
d1 = next dividend = $3
r = expected return = ?
g = growth rate of dividend = 8%, or 0.08
Substituting the values into equation (1) and solve for r, we have:
60 = 3 / (r - 0.08)
60(r - 0.08) = 3
60r - 4.80 = 3
60r = 3 + 4.80
r = 7.80 / 60
r = 0.13, or 13%
Therefore, the expected return is 13%.
