The constant growth valuation formula has dividends in the numerator. Dividends

Question

The constant growth valuation formula has dividends in the numerator. Dividends are divided by the difference between the required return and dividend growth rate as follows: p_0 = D_1/(r_s - g) Which of the following statements is true? Increasing dividends will always increase the stock price. Increasing dividends may not always increase the stock price, because less earnings may be invested back into the firm and that impedes growth. Increasing dividends will always decrease the stock price, because the firm is depleting internal funding resources. Walter Utilities is a dividend-paying company and is expected to pay an annual dividend of $1.25 at the end of the year. Its dividend is expected to grow at a constant rate of 6.50% per year. If Walter's stock currently trades for $22.00 per share, what is the expected rate of return? 12.18% 6.93% 6.55% 8.28% Walter's dividend is expected to grow at a constant growth rate of 6.50% per year. What do you expect to happen to Walter's expected dividend yield in the future? It will stay the same. It will decrease.

Explanation / Answer

1 As the Dividend is directly proportinal to the price, if there is increase in dividend the price will also increase The correct option is A. Increasing Dividend will always increase the stock price 2 Price = Dividend/ Rate of Return- Growth Rate 22= 1.25/(Ke-.065) Ke-.065 = 1.25/22 Ke-.065 = 0.05681818 Ke = .0568+.065 Ke = 12.18% The correct answer is A. 12.18%

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