Storico Co. just paid a dividend of $2.20 per share. The company will increase i

Question

Storico Co. just paid a dividend of $2.20 per share. The company will increase its dividend by 20 percent next year and will then reduce its dividend growth rate by 5 percentage points per year until it reaches the industry average of 5 percent dividend growth, after which the company will keep a constant growth rate forever. If the stock price is $33.97, what required return must investors be demanding on Storico stock? (Hint: Set up the valuation formula with all the relevant cash flows, and use trial and error to find the unknown rate of return.)

Explanation / Answer

33.97= 2.2x1.2/(1+K)+2.2x1.12x1.15/(1+K)^2+ 2.2x1.2x1.15x1.10/(1+K)^3+ 2.2x1.2x1.15x1.10x1.05/(K-.05)(1+K)^3

therefor K= roughly 14%

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