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21 April, 05:51

The current dividend yield on Clayton's Metals common stock is 3.2 percent. The company just paid a $1.48 annual dividend and announced plans to pay $1.54 next year. The dividend growth rate is expected to remain constant at the current level. What is the required rate of return on this stock?

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  1. 21 April, 06:32
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    Answer: 7.25%

    Explanation:

    To calculate this we will use the Constant Growth Model of calculating a Stock's price.

    The formula is,

    P = D1 / (r-g),

    where,

    P is the current price,

    D is the next dividend the company is to pay,

    g is the expected growth rate in the dividend payment and

    r is the required rate of return for the company.

    We were given the Dividend Yield and with this can calculate the Stock Price.

    The Dividend yield is the Dividend expressed as a percentage of Stock Price.

    Making the stock price x with the next dividend at $1.54 we have

    1.54 = 0.032x

    x = 1.54/0.032

    = $48.13

    Now that we have the stock price we can plug it into the formula.

    We also need to calculate the growth rate. Given that $1.48 was paid and $1.54 will be paid we can say,

    g = 1.54 - 1.48

    g = 0.06/1.48

    = 4.05% is what it will take to grow $1.48 to $1.54

    Now we can plug all these into the formula,

    Making r the subject we have,

    r = D1/P + g

    = 1.54/48.13 + 0.0405

    = 7.25%

    The required rate of return on this stock is therefore 7.25%.
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