George is considering an investment in Parson Inc.and has gathered the following information.What is the expected return for a share of the firm's stock?
A)5.00%
B)6.25%
C)8.33%
D)10.00%

Question

George is considering an investment in Parson Inc.and has gathered the following information.What is the expected return for a share of the firm's stock? 
A)5.00% 
B)6.25% 
C)8.33% 
D)10.00%

Quizplus · Accepted Answer

The expected return can be calculated as the sum of the expected dividend yield and the expected capital gains yield. Given that the current stock price is $40, the expected dividend of $1.50 per share provides a dividend yield of 3.75%. The expected capital gains yield can be calculated using the dividend growth model, which is based on the assumption that the firm's dividends will grow at a constant rate. Given that the firm's last dividend was $1.50, and the expected rate of dividend growth is 5%, the expected dividend next year will be $1.575 ($1.50 x 1.05). Therefore, the expected capital gains yield can be calculated as ($1.575/$40) - 1 = 3.94%. Thus, the expected return for a share of the firm's stock is 7.69% (3.75% + 3.94%), which is closest to 6.25% (Choice B).

George Is Considering an Investment in Parson Inc