The common stock of Dayton Repair sells for $50 a share. The stock is expected to pay $2.28 per share next year when the annual dividend is distributed. The firm has established a pattern of increasing its dividends by 5.0 percent annually and expects to continue doing so. What is the market rate of return on this stock

r = 0.0956 or 9.56%

Explanation:

Using the constant growth model of dividend discount model, we can calculate the price of the stock today. The DDM values a stock based on the present value of the expected future dividends from the stock. The formula for price today under this model is,

P0 = D1 / (1+g)

Where,

By plugging in the available values for P0, D1 and g, we can calculate the required rate of return (r) to be,

50 = 2.28 / (r - 0.05)

50 * (r - 0.05) = 2.28

50r - 2.5 = 2.28

50r = 2.28 + 2.5

r = 4.78 / 50

r = 0.0956 or 9.56%

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