Question

The current price of XYZ stock is $50.00. Dividends are expected to grow at 7% indefinitely and the most recent dividend was $1. What is the required rate of return on XYZ stock?

Answer 1

Answer:

Current market price (Po) = $50

Growth rate (g) = 7%

Dividend paid (Do) = $1

Required return (Ke) = ?

Po = Do(1 + g)

            Ke - g

$50 = $1( 1 + 0.07)

             ke - 0.07

$50 =      1.07

            Ke -  0.07

$50(Ke - 0.07) = $1.07

50Ke - 3.5    = $1.07

50Ke = $1.07 + $3.5

50Ke = $4.57

Ke = 4.57/50

Ke = 0.0914 = 9.14%                                                                                                                                                                                                                                        

Explanation:

The current market price of a stock equals current dividend paid, subject to growth rate, divided by the difference between required rate of return and growth rate. The current market price, growth rate and current dividend paid were provided in the question with the exception of the required return (Ke). Thus, the required return becomes the subject of the formula.