The current dividend yield on CJ's common stock is 1.89 percent. The company just paid an annual dividend of $1.56 and announced plans to pay $1.70 next year. The dividend growth rate is expected to remain constant at the current level. What is the required rate of return on this stock

The required rate of return is 11.025%

Explanation:

Dividend yield is a ratio which expresses dividend as a percentage of the current stock price.

Dividend Yield = Dividend / Current stock price

We calculate the current stock price to be,

0.0189 = 1.56 / Current stock price

Current stock price = 1.56 / 0.0189

Current stock price = 82.539 rounded off to $82.54

As the dividends of this stock are expected to grow at a constant rate, the constant growth model of DDM is applicable to calculate the price of the stock today. The formula for price under this model is,

P0 = D1  /  (r - g)

The constant growth rate is = (1.7 - 1.56) / 1.56 = 0.0897 or 8.97%

We already know the stock price, the dividend for the next period or D1 and the growth rate, we will plug in these figures in the price formula for constant growth model and calculate the required rate of return.

82.54 = 1.7 / (r - 0.0897)

82.54 * (r - 0.0897) = 1.7

82.54r - 7.40 = 1.7

82.54r = 1.7 + 7.40

r = 9.1 / 82.54

r = 0.11025 or 11.025%

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