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 $20.00 per share and that you should anticipate paying a dividend of $0.75 in one year.If you anticipate a constant growth in dividends of 3.00% per year and the investment banking firm will take 8.00% per share as flotation costs,what is the required rate of return for this issue of new common stock?
A)6.83%
B)7.08%
C)7.19%
D)10.20%

Question

Quizplus · Accepted Answer

The formula for the dividend growth model is:

Required Rate of Return = (Dividend / Price) + Growth rate

Here, Dividend = $0.75, Price = $20.00 - $1.60 (8% flotation cost) = $18.40, Growth rate = 3.00%.

Required Rate of Return = ($0.75 / $18.40) + 0.03 = 0.07 or 7.08% (rounded to two decimal places).

Therefore, the required rate of return for this issue of new common stock is 7.08%, which is option B.

Use the Dividend Growth Model to Determine the Required Rate