Question

Return on Common Stock You buy a share of The Ludwig Corporation stock for $21.40. You expect it to pay dividends of $1.07, $1.1449, and $1.2250 in Years 1, 2, and 3, respectively, and you expect to sell it at a price of $26.22 at the end of 3 years.

a. Calculate the growth rate in dividends.

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b. Calculate the expected dividend yield.

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c. Assuming that the calculated growth rate is expected to continue, you can add the dividend yield to the expected growth rate to obtain the expected total rate of return. What is this stock’s expected total rate of return?

Answer 1

Given data can be summarized below:

Price of the stock, = $21.40

Expected dividend in year 1, = $1.07

Expected dividend in year 2, = $1.1449

Expected dividend in year 3, = $1.225

a. Calculation of growth rate on dividends:

We know that, =

Here, Dividend in 2^nd year () = $1.1449,

Dividend in 1^st year () = $1.07.

By substituting these values in the above formula, we can get the growth rate of the dividends.

Therefore, growth rate of the dividends = $7%

b. Calculation of expected dividend yield:

Formula for dividend yield is below:

Dividend yield =

Here, dividend in the first year () = $1.07

Stock price () = $21.40.

By substituting these values in the expected dividend yield formula:

Dividend yield =

=

Therefore, dividend yield = 5%

c. Calculation of expected total rate of return:

Formula for expected total rate of return is below:

From the part 1, Growth rate is 7%,

From the part 2, Dividend yield is 5%.

By substituting these values in the expected total rate of return formula:

Therefore, expected total rate of return = 12%