Question

Walter utilities is a dividend-paying company and is expected to pay an annual dividend of $2.45 at the end of the year. It’s Dividend is expected to grow at a constant rate of 6.50% per year. If Walters stock currently trades for $29.00 per share, what is the expected rate of return?

Answer 1

Answer:

                 $\large\boxed{\large\boxed{14.9\%}}$

Explanation:

The value of a stock equals the flow of the dividends discounted at the expected rate of return.

The formula to calculate the value of a stock when the dividends are expected to grow at a constant rate g, when the expected rate of return is r, is:

      $Value=\frac{\text{dividend at the end of the first year}}{r-g}$

Here you know value = $29.00 per share, dividend at the end of the first year = $ 2.45 per share, constant rate at which the dividend is expected to grow r = 6.50%. Then, you can solve for r:

       $r-g=\frac{\text {dividend at the end of the first year}}{value}\\ \\ r=g+\frac{\text {dividend at the end of the first year}}{value}$

Substitute:

        $r=6.50\%+ 2.45/ 29.00=0.065+0.08448=0.14948=14.9\%$