Question

The current dividend yield on Clayton's Metals common stock is 3.2 percent. The company just paid a $1.48 annual dividend and announced plans to pay $1.54 next year. The dividend growth rate is expected to remain constant at the current level. What is the required rate of return on this stock?

Answer 1

Answer: 7.25%

Explanation:

To calculate this we will use the Constant Growth Model of calculating a Stock's price.

The formula is,

P = D1/(r-g),

where,

P is the current price,

D is the next dividend the company is to pay,

g is the expected growth rate in the dividend payment and

r is the required rate of return for the company.

We were given the Dividend Yield and with this can calculate the Stock Price.

The Dividend yield is the Dividend expressed as a percentage of Stock Price.

Making the stock price x with the next dividend at $1.54 we have

1.54 = 0.032x

x = 1.54/0.032

= $48.13

Now that we have the stock price we can plug it into the formula.

We also need to calculate the growth rate. Given that $1.48 was paid and $1.54 will be paid we can say,

g= 1.54 - 1.48

g= 0.06/1.48

= 4.05% is what it will take to grow $1.48 to $1.54

Now we can plug all these into the formula,

Making r the subject we have,

r = D1/P + g

= 1.54/48.13 + 0.0405

= 7.25%

The required rate of return on this stock is therefore 7.25%.