Question

Alaskan foodstuffs just announced the annual dividend for this coming year will be $0.36 a share and all future dividends are expected to increase by 4.5 percent annually. what is the market rate of return if the stock is currently selling for $12.20 a share?

Answer 1

Answer: The market rate of return is 7.45%

We follow these steps to find the answer.

Here we can interpret the term 'market rate of return' as the required rate of return on the stock. We represent this as $k_{e}$

The current market price of stock (P₀), whose dividends are expected to grow for a constant rate is given by:

$P_{0} = \frac{D_{1}}{k_{e}-g}$

where

D = Upcoming dividend

k_{e} = required rate of return on the stock

g  = constant growth rate of dividends.

Plugging in the values from the question in the formula above we get,

$12.20 = \frac{0.36}{k_{e} - 0.045 }$

$k_{e} - 0.045 = \frac{0.36}{12.20}$

$k_{e} = 0.029508197 + 0.045$

$k_{e}= 0.074508197$