Question #65
Reading: Reading 20 Discounted Dividend Valuation
PDF File: Reading 20 Discounted Dividend Valuation.pdf
Page: 25
Status: Correct
Correct Answer: A
Question
In its most recent quarterly earnings report, Smith Brothers Garden Supplies said it planned to increase its dividend at an annual rate of 13% for the foreseeable future. Analyst Clinton Spears has an annual return target of 15.5% for Smith Brothers stock. He decides to use the dividend-growth rate to back out another return estimate to test against his. Smith Brothers stock trades for $55 per share and earned $3.01 per share over the last 12 months. The company paid a dividend of $2.15 per share during the 12-month period, and its dividend- growth rate for the last five years was 9.2%. Using the Gordon Growth model, the required annual return for Smith Brothers stock is closest to:
Answer Choices:
A. 17.42%
B. 19.18%
C. 13.47%
Explanation
The Gordon Growth model is as follows:
Price = [dividend × (1 + dividend growth rate)] / [required return − growth rate]
55 = [2.15 × 1.13] / [required return − 0.13]
55 = 2.4295 / [required return − 0.13]
22.6384 = 1 / [required return − 0.13]
[Required return − 0.13] = 0.04417
Required return = 0.17417 = 17.42%