Copyright

Suppose Microsoft, Inc. is trading at $27.29 per share. It pays an annual dividend of $0.32 per...

Question:

Suppose Microsoft, Inc. is trading at $27.29 per share. It pays an annual dividend of $0.32 per share, which is double its last year's dividend of $0.16 per share. If this trend is expected to continue, what is the required return on Microsoft?

Required Return

The required rate of return is the minimum return an investor expects to get from an investment. The required rate of return is influenced by many factors but one key factor is the risk of the investment. The required return is always higher than the risk free rate because of the risk premium .

Answer and Explanation:

Using the dividend model the required return is computed as follows;

The CGDM formula is;

{eq}*K_e= D_1 / P_o + g {/eq}

where:

  • Po = Price of a stock
  • D1 = Next year's dividend(expected dividends)
  • Ke = Required return
  • g = Growth rate in dividends

Given:

  • Po = $27.29
  • D1 = $0.32(1+1) =0.64
  • Ke = to calculate
  • g = 100%

Therefore:

{eq}*K_e= 0.64 / 27.29 + 1 {/eq}

Ke = 102.35%


Learn more about this topic:

Loading...
The Dividend Growth Model

from Finance 101: Principles of Finance

Chapter 14 / Lesson 3
9.7K

Related to this Question

Explore our homework questions and answers library