Question

A firm has a current price of $40 a share, an expected growth rate of 11 percent and expected dividend per share (D1) of $2. Given its risk, you have a required rate of return for it of 12 percent. Your expected rate of return and investment decision is as follows:A) 10 percent  do not buyB) 12 percent  do not buyC) 14 percent  buyD) 16 percent  buyE) 18 percent  buy

Answer 1

Answer:

D) 16 percent -  buy

Explanation:

R = (D1 / P0) + g

R=Expected Return, P0=Current Market Price = $40, D1 = Expected Dividend = $2,  g=Expected Growth Rate = 11% = 0.11

Expected Return = R = (2/40)+0.11

R = 0.05+0.11

R = 0.16

R = 16%

The Expected Return is higher than the required return of 12%. Hence, it should be bought (it is expected to give higher return than required)