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ory Bookmarks People Window Help C Chegg Study | Guided Solutio ×e Chegg Study I Gulded Solutio let/quiz?ctx-brown1-0012 8quiz iz&quiz; probGuid-QNAPCOA801010000003e4313500900008ck m 151386880 6. Expected returns, dividends, and growth AaAa The constant growth valuation formula has dividends in the numerator. Dividends are divided by the difference between the required return and dividend growth rate as follows: Di if you were analyzing the consumer goods industry, for which kind of cormpany in the industry would the constant growth model work best? O All companies O Mature companies with relatively predictable earnings O Young companies with unpredcdable earnings Utilities is a dividend-paying company and is expected to pay an annual dividend of $0.85 at the end of the year. Its dividend is expected to grow at a constant rate of 8.00% per year. If water's stock currently trades for 19.00 per share, what is the expected rate of return? o 8.40% 12.47% 7.67% 8.04% Which, of the following conditions must hold true for the constant growth valuation formula to be useful and give meaningful results? O The company's stock cannot be a zero growth stock. O The required rate of return, rs, must be greater than the long-run growth rate. The company's growth rate needs to change as the company matures.Explanation / Answer
Answer 1.
Mature companies with relatively predictable earnings can work with constant growth model.
Young companies cannot work with constant growth model as they cannot increase their dividend constantly.
Answer 2.
D1 = $0.85
growth rate, g = 8.0%
Current Price, P0 = $19.00
Required Rate of Return = D1 / P0 + g
Required Rate of Return = $0.85 / $19.00 + 0.08
Required Rate of Return = 0.1247
Required Rate of Return = 12.47%
Answer 3.
Following conditions must hold for the constant growth valuation formula:
The company’s stock cannot be a zero growth stock
The required rate of return, rs, must be greater than the long-term growth rate.
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