Question

Jand, Inc., currently pays a dividend of $1.38, which is expected to grow indefinitely at 5%. If the current value of Jand’s shares based on the constant-growth dividend discount model is $35.41, what is the required rate of return? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Answer 1

Answer:

9.09%

Explanation:

Use Gordon growth model of stock valuation to find the required rate of return;

Price = D1/ (r-g)

this can also be written as $\frac{D0(1+r)}{(r-g)}$

whereby,

Price = $35.41

D0 = Current dividend = 1.38

D1 = Next year's dividend = 1.38(1.05) = 1.449

g = growth rate = 5% or 0.05 as a decimal

r = required return = ?

Rewrite the formula "Price = D1/ (r-g) " to find r;

r = $\frac{D1}{Price} +g$

r = $\frac{1.449}{35.41} + 0.05\\ \\ =0.04092 +0.05\\ \\ =0.09092$

as a percentage, the required return = 9.09%