11. Potential investors of XYZ Corp. stock are looking for a 20% expected return. XYZ
currently trades at $15 per share and has just paid an annual dividend of $2 per share.
Based on the above what is the implied growth rate in dividends for XYZ Corp.?
A) 5.00%
B) 5.88%
C) 6.25%
D) 6.67%
E) 7.14%
Answer B
We need to solve for g, where g represents both the growth rate in dividends and the
growth rate in the stock price.
Investors total expected return; r = 20% = D
1/P
0 + g
Solving for g the formula becomes g = r – (D
1/P
0); note also that D
1 = D
0 (1 + g)
g = r - [D
0 (1 + g)]/ P
0 = 20% - [$2 x (1 + g)] / $15
Î g = 0.0588 or 5.88%
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