Question

The common stock of sweet treats is valued at $10.80 a share. the company increases its dividend by 8 percent annually and expects its next dividend to be $0.40 per share. what is the total rate of return on this stock?

Answer 1

Using the Gordon Growth Model (a.k.a. Dividend Discount Model), the intrinsic value of a stock can be calculated, exclusive of current market conditions. In this model, the value of the stock is equated to the present value of the stock's future dividends. 

Value of stock (P0) = D1 / (k - g)

where
D1 = expected annual dividend per share in the following year 
k = the investor's discount rate or required rate of return
g = the expected dividend growth rate 

From the problem:
The value of stock is $10.80
D1 is $0.40
g is 0.08

k is unknown

Solution:
Rearranging the equation for Gordon Growth Model to solve for k:

k = (D1/P0) + g

Substituting the variables with the given values, 

k = (0.40/10.80) + 0.08
k = 0.1170

In percent form, this is
0.1170 * 100% = 11.70%.

Thus, the total rate of return on the stock is 11.70%.