PLEASE SHOW STEPS: Use the dividend growth model to determine the rate of return

Question

PLEASE SHOW STEPS: Use the dividend growth model to determine the rate of return for equity. Your firm intends to issue new common stock. Your investment bankers have determined that the stock should be offered at a price of $50 per share and that you should anticipate paying a dividend of $1 per share in one year. If you anticipate a constant growth rate in dividends of 4% per year and the investment banking firm will take 6% per share as floatation costs, what is the required rate of return for this issue of new common stock?

Explanation / Answer

Price recieved after deduction of flotation Cost = 50 -6%*50 = 47

As per DDM

Price = D1/(Required rate of return - growth)

47 = 1/(Required rate of return - 0.04)

Required rate of return = 1/47 + 0.04 = 0.0613 or 6.13%

Answer: 6.13%

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