Storico Co. just paid a dividend of $1.30 per share. The company will increase i
ID: 2650597 • Letter: S
Question
Storico Co. just paid a dividend of $1.30 per share. The company will increase its dividend by 20 percent next year and will then reduce its dividend growth rate by 5 percentage points per year until it reaches the industry average of 5 percent dividend growth, after which the company will keep a constant growth rate forever. If the stock price is $34.14, what required return must investors be demanding on Storico stock? (Hint: Set up the valuation formula with all the relevant cash flows, and use trial and error to find the unknown rate of return.) (Do not round intermediate calculations and round your final answer to 2 decimal place. (e.g., 32.16))
Storico Co. just paid a dividend of $1.30 per share. The company will increase its dividend by 20 percent next year and will then reduce its dividend growth rate by 5 percentage points per year until it reaches the industry average of 5 percent dividend growth, after which the company will keep a constant growth rate forever. If the stock price is $34.14, what required return must investors be demanding on Storico stock? (Hint: Set up the valuation formula with all the relevant cash flows, and use trial and error to find the unknown rate of return.) (Do not round intermediate calculations and round your final answer to 2 decimal place. (e.g., 32.16))
Explanation / Answer
Answer:
Calculation of required rate of return
Year 0
Year 1
Year 2
Year 3
Year 4
Year 5
Growth rate
20%
15%
10%
5%
5%
Dividend
$ 1.5600
$ 1.7940
$ 1.9734
$ 2.0721
$ 2.1757
(1.30*120%)
(1.5600*115%)
(1.7940*110%)
(1.9734*105%)
(2.0721*105%)
Price at the end of year 4
= Year 5 Dividend / 5%
$ 43.5140
(2.1757 /5%)
Stock Price Today
$ 34.14
Net cash flows
$ 34.14
$ 1.76
$ 1.94
$ 2.07
$ 45.64
Calculation of required rate using IRR formula :
IRR =
11.52%
Hence Required return is 11.52%
Calculation of required rate of return
Year 0
Year 1
Year 2
Year 3
Year 4
Year 5
Growth rate
20%
15%
10%
5%
5%
Dividend
$ 1.5600
$ 1.7940
$ 1.9734
$ 2.0721
$ 2.1757
(1.30*120%)
(1.5600*115%)
(1.7940*110%)
(1.9734*105%)
(2.0721*105%)
Price at the end of year 4
= Year 5 Dividend / 5%
$ 43.5140
(2.1757 /5%)
Stock Price Today
$ 34.14
Net cash flows
$ 34.14
$ 1.76
$ 1.94
$ 2.07
$ 45.64
Calculation of required rate using IRR formula :
IRR =
11.52%
Hence Required return is 11.52%
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