Use the dividend growth model to determine the required rate of return for equity.Your firm intends to issue new common stock.Your investment bankers have determined that the stock should be offered at a price of $45.00 per share and that you should anticipate paying a dividend of $1.50 in one year.If you anticipate a constant growth in dividends of 3.00% per year and the investment banking firm will take 5.00% per share as flotation costs,what is the required rate of return for this issue of new common stock?
A)6.51%
B)6.83%
C)7.08%
D)There is not enough information to answer this question.

Question

Quizplus · Accepted Answer

The correct answer is A because the required rate of return for equity is 6.51%. The dividend growth model is used to determine the required rate of return for equity. The formula for the dividend growth model is:Required rate of return = Dividend yield + Growth rateThe dividend yield is the dividend per share divided by the stock price. The growth rate is the constant growth rate in dividends.In this case, the dividend per share is $1.50, the stock price is $45.00, and the growth rate is 3.00%. Therefore, the dividend yield is 1.50 / 45.00 = 0.0333 and the growth rate is 0.03.Therefore, the required rate of return is 0.0333 + 0.03 = 0.0651, or 6.51%.

Use the Dividend Growth Model to Determine the Required Rate