You are a financially educated investor and after thorough

. You are a financially educated investor and after thorough analysis, you purchased Crandles common stock for $79 per share. It just paid a dividend of S4.60 and dividends are expected to grow at a rate of 5% indefinitely. What is your Required Rate of Return on Candes a. 11.76% b. 10.8% c. 12.2% d. 14.21%

Solution

1) Computation of required rate of return on Crandle\'s :-

By using Gordon Growth Model,

Value of stock = D₁/ (k - g)
where:
D₁ = next year\'s expected annual dividend per share
k = the investor\'s discount rate or required rate of return, which can be estimated using the Capital Asset Pricing Model or the Dividend Growth Model (see Cost of Equity)
g = the expected dividend growth rate (note that this is assumed to be constant)

Here, given value of the stock = $ 79 per share

Dividend paid (Do) = $4.60

Expected annual dividend (D1 ) = (Do + g)   = ($ 4.60+5%) = $ 4.83

Value of stock = D₁/ (k - g)

By substituting the values on the above formulae,

$ 79 = $4.83 / k - 0.05

k-0.05 = $4.83/$79

k-0.05 = 0.061139

k = 0.05+0.061139

k = 0.111139

k = 11.11 %

Therefore, required rate of return is 11.11%.