Determine the value of the stock if the required rate of return is 12 and 15 percent in the following case:
A corporation earned $2.60 per share and paid a dividend of $1.90 per share in the year just ended. Earnings and dividends per share are expected to grow at a rate of 5 percent per year in the future.
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The corporation's earnings are $2.6 per share and the dividend paid is $1.9. Both of these are expected to grow at 5% per year.
Let the price of the share when it is bought be P. The dividend yield of the share is 1.9/P. If the share trades at the same P/E ratio after a year, the price of the share increases by 5%. The yield to the investor due to a rise in the price of the share is 0.05
An investor buying the share at a price P earns 0.05 + 1.9/P. If the required rate of return is 12%, 0.05 + 1.9/P = 0.12 or P = $27.14. If the share has a market price of $27.14, the investor makes a return of 12%.
If the required rate of return is 15%, 0.05 + 1.9/P = 0.15 or P = $19. The market price of the share should be $19 for the returns to the investor to be 15%.
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