Question

reliable electric is a regulated public utility, and it is expected to provide steady growth of dividends of 5% per year for the indefinite future. its last dividend was $5 per share; the stock sold for $60 per share just after the dividend was paid. what is the investors required rate of return (or discount rate)?

Explanation:

Step1: Use the Gordon Growth Model formula

The Gordon Growth Model formula is $r=\frac{D_1}{P_0}+g$, where $r$ is the required rate of return, $D_1$ is the next - year dividend, $P_0$ is the current stock price, and $g$ is the growth rate of dividends.

We know that the last dividend $D_0 = 5$. Since the growth rate $g=5\%=0.05$, then $D_1=D_0(1 + g)$. So $D_1=5\times(1 + 0.05)=5.25$. And $P_0 = 60$.

Step2: Calculate the required rate of return

Substitute $D_1 = 5.25$, $P_0 = 60$, and $g = 0.05$ into the Gordon Growth Model formula $r=\frac{D_1}{P_0}+g$.

We get $r=\frac{5.25}{60}+0.05$.

First, calculate $\frac{5.25}{60}=0.0875$. Then $r=0.0875 + 0.05=0.1375 = 13.75\%$.

Answer:

E. 13.75%