Question

The common stock of Auto Deliveries sells for $29.37 a share. The stock is expected to pay $2.45 per share next year when the annual dividend is distributed. The firm has established a pattern of increasing its dividends by 1.5 percent annually and expects to continue doing so. What is the market rate of return on this stock?

A. 9.07%

B. 9.42%

C. 9.67%

D. 9.84%

Answer 1

To solve this problem, we use the Gordon Growth Model formula to calculate the market rate of return. The formula is:

r = D1/P0 + g

where:
- r is the required rate of return,
- D1 is the dividends expected next year,
- P0 is the current price of the stock,
- g is the growth rate of dividends.

Plugging our values into this formula, we have:

r = (2.45/29.37) + 0.015

After simplifying the part in parentheses, we add 0.015 to find the market rate of return.

To convert this rate to a percentage, we multiply the decimal by 100.

Having performed these calculations according to the Gordon Growth Model formula, we find that the market rate of return on this stock is approximately 9.84%.

So, the correct answer is D. 9.84%.