The common stock of Denis and Denis Research, Inc., trades for $60 per share. Investors expect the company to pay a(n) $3.90 dividend next year, and they expect that dividend to grow at a constant rate forever. If investors require a(n) 10% return on this stock, what is the dividend growth rate that they are anticipating?

The constant growth rate that the investors are anticipating is 3.5%

Explanation:

The price of a stock whose dividends are expected to grow at a constant rate forever can be calculated using the constant growth model of the dividend discount model approach. The DDM values the stock based on the preset value of the expected future dividends from the stock. The price of the stock today under this model is,

P0 = D1 / r - g

As we know the price today, the dividend for the next period or D1 and the required rate of return on the stock, plugging in these variables in the formula, we can calculate the growth rate or g to be,

60 = 3.9  /  (0.1 - g)

60 * (0.1 - g)  =  3.9

6 - 60g  = 3.9

6 - 3.9  =  60g

2.1 / 60  = g

g = 0.035 or 3.5%

3.5%

Explanation:

Dividend Valuation method is used to value the stock price of a company based on the dividend paid, its growth rate and rate of return. The price is calculated by calculating present value of future dividend payment.As we have the value of share we just need to calculate the growth rate of dividend.

Value of stock = Dividend / (Rate of return - Growth rate)

$60 = $3.90 / ( 10 % - g )

10% - g = $3.90 / $60

10% - g = 6.5%

-g = 6.5% - 10%

-g = -3.5%

g = 3.5%

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