A firm pays a $1.50 dividend at the end of year one ( D 1 ), has a stock price o

Question

A firm pays a $1.50 dividend at the end of year one (D1), has a stock price of $80 (P0), and a constant growth rate (g) of 10 percent.    
  
a. Compute the required rate of return (Ke).

Indicate whether each of the following changes will increase or decrease the required rate of return (Ke). (Each question is separate from the others. That is, assume only one variable changes at a time.) No actual numbers are necessary.
  
b. If the dividend payment increases:

Divided yield- ?

Required rate of return- ?

c. If the expected growth rate increases:

d. If the stock price increases:
Divided yield- ?

Required rate of return- ?

Explanation / Answer

a) Required rate of return, Ke = D1 / P0 + g = 1.5 / 80 + 10% = 11.875%

b) If dividend payment increases, Dividend yield (D1 / P) increases and hence, required return (Ke) increases as well.

c) If expected growth rate (g) increases, required return (Ke) increases.

d) If the stock price (P0) increases, dividend yield (D1/P0) decreases and hence, Ke decreases.

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