Harrison Clothiers' stock currently sells for $20.00 a share. It just paid a dividend of $1.00 a...

Question:

Harrison Clothiers' stock currently sells for $20.00 a share. It just paid a dividend of $1.00 a share (that is, D0=$1.00). The dividend is expected to grow at a constant rate of 6% a year.

1. What stock price is expected 1 year from now?

2. What is the required rate of return?

Required Rate of Return:

The rate that an investor expects from his equity-investment in the company is called the required return. A company issues stock so that it can raise capital from the investor and invest in various investments that achieve yields higher than the required return expected by the investors. The profit that is achieved is the difference between the return on investment to the company reduced by the required return of the shareholders.

Answer and Explanation:


Answer:

The computations for Harrison Clothiers are made below:

Data:

  • Current stock price, P0 = $20 per share
  • Last dividend, D0 = $1
  • Constant growth rate, g = 6%
  • Price in year 1, P1 =?
  • Required return, Ke =?

Requirement 1:

The stock price that is expected 1 year from now is $21.20

Computation:

  • P1 = {eq}P0 * (1 + g)^1 {/eq}
  • P1 = {eq}$20 * (1 + 0.06)^1 {/eq}
  • P1 = {eq}$20 * (1.06) {/eq}
  • P1 = {eq}$21.20 {/eq}

Requirement 2:

The required return on Harrison Clothiers' stock is 11.30%.

Computation:

  • Ke = (D0 * (1 + g) / P0) + g
  • Ke = ($1 * (1 + 0.06) / $20) + 0.06
  • Ke = 0.053 + 0.06
  • Ke = 11.30%

Learn more about this topic:

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Required Rate of Return (RRR): Formula & Calculation

from Financial Accounting: Help and Review

Chapter 1 / Lesson 31
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