Question

A firm pays a $1.50 dividend at the end of year one. It has a share price of $60 (P) and a constant growth rate (g) of 9 percent. a. Compute the required (expected) rate of return (KJ. (Do not round Intermediate calculations, Round the final answer to 2 decimal places.) Required rate of return Also indicate whether each of the following changes would make the required rate of retum (K) go up or down, in each question below, assume only one variable changes at a time. No actual numbers are necessary) b. If the dividend payment increases: Ke will go up. Ke will go down ke remains constant. c. If the expected growth rate increases: Ke will go up. Ke will go down 43 of 43 Next

Answer 1

a)

Given, Share price = $ 60

Growth rate, g = 9 %

Dividend , D0 = $ 1.50

Required rate of return, ke = ?

60 = D0*(1+g)/ (k-g) = 1.50*(1+9%)/(ke - 9%)

40 = (1.09)/(ke - 9%)

ke - 9% = 1.09/40 = 2.725%

Ke = 11.725% = 11.73%

b)

If the dividend payment increases

ke = D1/P0 + g

As ke is directly proportional to D0, the ke will also increase with increase in dividend payment. ie ke will go up.

c)

If g increases, as ke is directly proportional to g, ke will go up.