Question

A firm has a current price of $40 a share, an expected growth rate of 11 percent and expected dividend per share (D1) of $2. Given its risk, you have a required rate of return for it of 12%. Your expected rate of return and investment decision is as follows:a. 10% - do not buy.b. 12% - do not buy.c. 14% - buy.d. 16% - buy.e. 18% - buy.

Answer 1

Answer:

d. 16% - buy

Explanation:

R = (D1 / P0) + g

Where, R=Expected Return, P0 = Current Market Price = $40, D1=Expected Dividend=$, g = Expected Growth Rate = 11% = 0.11

Expected Return = R = ($2/$40) + 11%

R = 0.05 + 0.11

R = 0.16

R = 16%

Expected Return is higher than the required return of 12%.  Hence, it should be bought (it is expected to give higher return than required)