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

A. 16.71%

Step-by-step explanation:

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

Formula for finding the required return of a stock is;

r =
`(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 =
`(3.45)/(17.50) -0.03\\ \\ =0.19714 - 0.03\\ \\ =0.16714`

As a percentage , it becomes 16.71%