Question

Suppose a company has a unique dividend policy. The firm has expects to pay a dividend of $3.45 in the next year. They anticipate decreasing the dividend 3% per year, indefinitely. If the current stock price is $17.50, what is the required rate of return by shareholders?
A. 16.71%
B. 21.66%
C. 16.12%
D. 22.71%
E. 20.31%

Answer 1

Answer:

A. 16.71%

Explanation:

Use dividend discount model (DDM) to solve this question.

Formula for finding the required return of a stock is;

r = $\frac{D1}{P0} +g$

where P0 = Current price = $17.50

D1 = Next year's dividend = $3.45

r= required return = ?

g= growth rate = -3% or -0.03 as a decimal (negative sign is because dividend is expected to decrease)

r = $\frac{3.45}{17.50} -0.03\\ \\ =0.19714 - 0.03\\ \\ =0.16714$

As a percentage , it becomes 16.71%