Lake Shore Vineyards recently paid a $4.20 annual dividend on their common stock. This dividend increases at an average rate of 4.2% per year. The stock is currently selling for $80.65 a share. What is the market rate of return?

Question

Quizplus · Accepted Answer

The market rate of return can be calculated using the dividend discount model for a stock with constant growth, which is given by the formula: $ r = \frac{D_1}{P_0} + g $, where $ r $ is the required rate of return, $ D_1 $ is the dividend next year, $ P_0 $ is the current price of the stock, and $ g $ is the growth rate of the dividend. Given that the dividend next year, $ D_1 $, can be calculated as $ D_0 \times (1 + g) = 4.20 \times (1 + 0.042) = 4.20 \times 1.042 = 4.3764 $, and using the current stock price $ P_0 = 80.65 $ and the growth rate $ g = 4.2\% $ or 0.042, we substitute these values into the formula to get $ r = \frac{4.3764}{80.65} + 0.042 $, which simplifies to approximately 0.0543 or 5.43% when expressed as a percentage. However, the correct calculation should result in a rate that reflects both the dividend yield and the growth, which would be closer to 9.63%, indicating a mistake in the initial calculation. The correct approach should directly apply the given growth rate and the initial dividend to find the expected rate of return, which includes both the dividend yield and the growth rate, leading to the correct answer of 9.63%. This discrepancy suggests a misunderstanding in the explanation provided, as the correct calculation method indeed yields an answer that aligns with option E, reflecting both the dividend yield and the growth in the stock price, which is what investors would expect as their total rate of return.

Lake Shore Vineyards Recently Paid a $4