Sparrow Products Industries stock is currently selling for $80. It just paid its annual dividend of $2 after reporting an ROE of 15%. The firm pays out 50% of its earnings as dividends. What is the expected return of this stock?

Expected return on stock = 9.68%

Explanation:

Cost of equity can be ascertained using the dividend valuation model. The model states that the price of a stock is the present value of future dividends discounted at the required rate of return.  

Ke=( Do( 1+g)/P ) + g  

g- growth rate in dividend, P- price of the stock,  Ke- required return, D- dividend payable in now

DATA

D0- 2, g- ?,  P- 80

Note that the growth rate in dividend is missing so we wold work it out as follows:

g = dividend retention rate ×Return on equity

g = 0.15*0.5 = 7%

Expected return on stock

= (2× (1+0.07)/80)  +  0.07 = 0.09675

Expected return on stock =  0.09675  × 100 = 9.675

Expected return on stock = 9.68%

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