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Constant-Growth Model: Rate of Return, Discount Rate

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A stock sells for $40. The next dividend will be $4 per share. If the rate of return earned on reinvested funds is 15 percent and the company reinvests 40 percent of earnings in the firm, what must be the discount rate?

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Solution Summary

Stock valuation formula is used to calculate the answer to this problem, which is given in a step by step method for easy understanding. A reverse formula is then used to double check the answer.

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The stock valuation formula is: P = div/[rate of return - growth rate]

Where P = Stock price
g = growth rate
div = next dividend
...

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