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Common Stocks

28. A firm pays a $1.90 dividend at the end of year one (D1), has a stock price of $40 (P0), and a constant growth rate (g) of 8 percent.

a. Compute the required rate of return (Ke). Also indicate whether each of the following changes would make the required rate of return (Ke go up or down. (For parts b, c, and d below, assume only one variable changes at a time. No actual numbers are necessary.)
b. The dividend payment increases.
c. The expected growth rate increases.
d. The stock price increases.

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a. Required rate of return (Ke)

P = D0(1 + g) where D0 is the dividend this year
(k - g) k is the require rate of return
g is the growth rate

$40 = $1.90
(k - ...

Solution Summary

This solution is comprised of a detailed explanation to compute the required rate of return (Ke) and also indicate whether the increase in dividend payment, the increase in the expected growth rate, and the increase in the stock price would make the required rate of return (Ke go up or down.)

$2.19