A firm pays a current dividend of $2, which is expected to grow at a rate of 9%

Question

A firm pays a current dividend of $2, which is expected to grow at a rate of 9% indefinitely. If the current value of the firm’s shares is $218, what is the required return applicable to the investment based on the constant-growth dividend discount model (DDM)? (Do not round intermediate calculations.)

A firm pays a current dividend of $2, which is expected to grow at a rate of 9% indefinitely. If the current value of the firm’s shares is $218, what is the required return applicable to the investment based on the constant-growth dividend discount model (DDM)? (Do not round intermediate calculations.)

Explanation / Answer

According to the constant-growth dividend discount model, the value of the share can be calculated as:

P0 = D1 / K -g = D0 ( 1+g) / K- g, where, D0 is the current dividend, D1 is the expected dividend in year 1, K is the required rate of return on investment and g is the expected percent growth in dividend.

Therefore, in the given question, 218 = 2 ( 1+ 0.09) / K - 0.09 or K is 10%

The required return applicable to the investment is 10%.

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