What is the required return if the next dividend payment by Savitz, Incorporated, will be $4.75 per share, and the dividends are anticipated to maintain a growth rate of 4 percent forever while the stock currently sells for $58 per share?
The required return can be calculated using the Gordon Growth Model, which is a formula used to value stocks that pay dividends with a constant growth rate. The formula is as follows:
Required Return = Dividend / Current Stock Price + Growth Rate
Given:
- Dividend = $4.75 per share
- Current Stock Price = $58 per share
- Growth Rate = 4% (0.04)
Plugging the values into the formula:
Required Return = $4.75 / $58 + 0.04
Required Return = 0.0819 or 8.19%
Therefore, the required return is 8.19%.
None of the provided multiple-choice options matches the calculated required return of 8.19%.
Explanation:
The Gordon Growth Model is a widely used method for estimating the required return on equity. It assumes that dividends will grow at a constant rate indefinitely. In this case, Savitz, Incorporated is expected to maintain a growth rate of 4 percent forever.
Calculating Required Return:
To calculate the required return, we first need to determine the Dividend, Current Stock Price, and Growth Rate.
- Dividend = $4.75 per share
- Current Stock Price = $58 per share
- Growth Rate = 4% or 0.04
Now, we can apply the Gordon Growth Model formula:
Required Return = Dividend / Current Stock Price + Growth Rate
Required Return = $4.75 / $58 + 0.04
Required Return = 0.0819 or 8.19%
Interpretation of Results:
The calculated required return of 8.19% indicates the minimum return an investor should expect to receive on their investment in Savitz, Incorporated stock. This return is based on the current stock price, anticipated dividend growth rate, and dividend payment amount.
It is important for investors to compare the required return to their expected return or the returns available from alternative investments. If the required return is higher than expected returns or alternative investments, the stock may not be considered a good investment opportunity.
In conclusion, the required return can be calculated using the Gordon Growth Model, which considers the dividend amount, current stock price, and growth rate. Understanding the required return is essential for investors to make informed decisions about their investments.