IBM's stock price is $22, it is expected to pay a $2 dividend, and analysts expect the firm to grow at 10 percent per year for the next five years. TDI's stock price is $10, it is expected to pay a $1 dividend, and analysts expect the firm to grow at 12 percent per year for the next five years. What is the difference in the two firms' required rates of return?
A) 2.91 percent
B) 1.82 percent
C) 2.03 percent
D) 3.23 percent

Question

Quizplus · Accepted Answer

The required rate of return can be calculated using the Gordon Growth Model: Required Return = (Dividend/Price) + Growth Rate. For IBM: (2/22) + 0.10 = 0.1909 or 19.09%. For TDI: (1/10) + 0.12 = 0.22 or 22%. The difference is 22% - 19.09% = 2.91%.

IBM's Stock Price Is $22, It Is Expected to Pay