# Tom Laboratory's common stock is currently selling at $60 per share. The next annual dividend is... ## Question: Tom Laboratory's common stock is currently selling at$60 per share. The next annual dividend is expected to be $3 per share, and the earnings, dividends, and stock prices are expected to grow at a rate, of (a) 0 percent, (b) 4 percent, and (c) 6 percent. What is the expected total return in each case from the purchase of the common stock? ## Required Rate of Return at Different Growth Rates The required rate of return on a common stock consists of dividend yields and capital gains. The stock is expected to grow at a rate perpetually. The growth rate implies the future economics of business, market and industry growth trends, and the economy as a whole. ## Answer and Explanation: Given the following information about Tom Laboratory, {eq}P_0 =$60 {/eq}

{eq}D_1 = $3 {/eq} The expected return on the common stock for each of these growth rates can be calculated as follows: {eq}R_E = D_1/P_0 + g {/eq} Using growth rate of 0%, the return on the stock is: {eq}R_E =$3/$60 + 0.00 {/eq} {eq}R_E = 0.05+0.00 {/eq} {eq}R_E = 0.05*100 = 5\% {/eq} Therefore, the required rate of return on the stock is 5%. The expected return on the stock using the growth rate of 4% is 9%. {eq}R_E =$3/$60 + 0.04 {/eq} {eq}R_E = 0.05+0.04 {/eq} {eq}R_E = 0.09*100 = 9\% {/eq} The expected return on the stock using the growth rate of 6% is 11%. {eq}R_E =$3/\$60 + 0.06 {/eq}

{eq}R_E = 0.05+0.06 {/eq}

{eq}R_E = 0.11*100 = 11\% {/eq} 