PQR Corp. shares currently sell for $$37.$ It just paid a dividend of $$2\mathrm{.}25,$ and expected to grow at

a constant rate of $4\%$ per year. What will be the expected stock price next year and the required

rate of return?

Hint:

We can use the Gordon Growth Model $($Dividend Discount Model$)$ to calculate the expected stock

price next year :

$()$

$()$

$0$

$1$

D$*$ g $1$

P

r g

$+=$

Where:

D$0$ : current dividend $($$$2\mathrm{.}25)$

g $=$ constant growth rate of dividends $(4\%)$

r $=$ required rate of return

Using DDM we can calculate expected stock price next year as:

P$1=[2\mathrm{.}25*(1\mathrm{.}04)]/($r$-0\mathrm{.}04)$

We also know that expected stock price next year will increase with the growth in dividends as:

P P$*$ g $*.10=+=+(1371004)()$

Using the two equations through substitution will give us the required rate of return $($r$)$