Virgo Airlines will pay a $4 dividend next year on its common stock, which is currently selling at $100 per share. What is the market's required return on this investment if the dividend is expected to grow at 5% forever?
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A. B. C. D.D
The question requires us to determine the market's required return on an investment in Virgo Airlines' common stock, given that the stock currently sells at $100 per share, and the company is expected to pay a dividend of $4 next year. Additionally, the dividend is expected to grow at a constant rate of 5% forever.
The market's required return on a stock is also known as the stock's cost of equity. This is the minimum return that investors require to invest in the stock, given its level of risk. The cost of equity can be calculated using the following formula:
Cost of Equity = Dividend Yield + Growth Rate
where Dividend Yield = Dividend / Stock Price
In this case, the Dividend Yield can be calculated as:
Dividend Yield = Dividend / Stock Price = $4 / $100 = 0.04 or 4%
Next, we need to calculate the growth rate, which is given as 5%.
Therefore, the cost of equity can be calculated as:
Cost of Equity = Dividend Yield + Growth Rate = 4% + 5% = 9%
Therefore, the market's required return on an investment in Virgo Airlines' common stock is 9%, which is option D in the answer choices.
In summary, the market's required return on an investment in Virgo Airlines' common stock can be calculated using the formula: Cost of Equity = Dividend Yield + Growth Rate. The dividend yield can be calculated as the dividend divided by the stock price, while the growth rate is given in the question. Applying this formula yields a cost of equity of 9%, which is the market's required return on the investment.