Given that the P/E ratio on a common stock is 12, the expected dividend payout ratio is 0.7, and the dividend growth rate is 6%, what is the required rate of return?
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A. B. C. D. E.E
The infinite period Dividend Discount Model claims that the current price of a common stock is equal to D1 / (k - g), where D1 is next period's (most often next year's) dividend, k is the required rate of return, and g is the growth rate of dividends. The earnings multiplier model goes a step further by dividing both sides of the infinite period Dividend Discount Model equation by expected earnings during the next 12 months, yielding P/E = (D1/E) / (k - g). Rearranging this results in k = (D1/E) / (P/E) + g. In this question the required rate of return is equal to 0.7/12 + 0.06 = 0.118 =
11.8%.