Modem Development,Inc.paid a dividend of $5.00 per share on its common stock yesterday.Dividends are expected to grow at a constant rate of 10% for the next two years,at which point the dividends will begin to grow at a constant rate indefinitely.If the stock is selling for $50 today and the required return is 15%,what it the expected annual dividend growth rate after year two?

Question

Quizplus · Accepted Answer

The correct answer is A because the expected annual dividend growth rate after year two is 3.365%. This can be calculated using the Gordon Growth Model, which states that the expected return on a stock is equal to the dividend yield plus the expected dividend growth rate. In this case, the dividend yield is 5% ($5/$50) and the expected dividend growth rate is 10% for the next two years. After year two, the dividend growth rate is expected to be 3.365%.