Company B is expected to pay a dividend of $2 per share at the end of year 1 and the dividends are expected to grow at a constant rate of 4 percent forever. If the current price of the stock is $20 per share, calculate the expected return (i. e., the cost of equity capital for the firm)

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Business

Valery Figueroa

16 September, 22:47

Company B is expected to pay a dividend of $2 per share at the end of year 1 and the dividends are expected to grow at a constant rate of 4 percent forever. If the current price of the stock is $20 per share, calculate the expected return (i. e., the cost of equity capital for the firm)

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Answers (1)

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Salvador Sloan · Answer 1

The answer is 14%

Explanation:

This will be solved by Dividend discount model based approach

re = D1/Po + g

where re is the rate of return

D1 is expected dividend ($2)

Po is the current market value of equity ($20)

g is the expected growth rate of dividend (4% or 0.04)

2/20 + 0.04

0.1 + 0.04

= 0.14

Expressed as a percentage is

0.14 x 100

14%

Therefore, the expected return is 14%