Gerald's Travel Service just paid $1.79 to its shareholders as the annual dividend. Simultaneously, the company announced that future dividends will be increasing by 3.2%.
If you require a 10.5% rate of return, how much are you willing to pay to purchase one share of this stock?
Required Rate of Return:
The required rate of return on a stock could be estimated using either the discounted cash flow approach or the capital asset pricing model. In the former, the required rate of return is the sum of dividend yield and dividend growth rate.
Answer and Explanation:
We can use the dividend growth model to compute the price per share of the stock:
- price per share = last dividend *(1 + dividend growth rate) / (required return - dividend growth rate)
- price per share = 1.79 *(1 + 3.2%) / (10.5% - 3.2%)
- price per share = 25.31
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Learn more about this topic:
from Finance 101: Principles of FinanceChapter 14 / Lesson 3