CF 5-2A – Dividend Discount Model - Calculating the Required Return – Corporate Finance

Let's go through problem five to a more on the dividend discount model this time with a little algebra at the start, uh, because we're not solving for P zero. We're calculating the required return. We're calculating are we're solving for that one. So, uh, let's look at the problem and see what we're up against. Stratford partners will pay a dividend of $4 per share next year. The dividends are expected to increase by 5% per year going forward. So first of all, uh, they will pay a dividend of $4 per share next year. This is D one. The dividends are expected to increase by 5% per year going forward. That is G, uh, and the stock price today is $50. That's P naught or P at time zero. Okay. Calculate the equity of cost of capital. That's solved for R so we can sort of rearrange this and I'll do, I'll show you the algebra here. So I'm going to multiply both sides by R minus G. So I get P naught times R minus G equals D one. I'm going to divide both sides by P zero. I'm trying to isolate the R. I'm going to divide both sides by P zero. So I get R minus G equals D one over P zero. And again, I'm isolating the R. So I just add G to both sides. So I get R equals D one over P zero plus G welcome to finance. There's a fair amount of algebra. You probably didn't need to go through that to solve this, but it's useful in explaining what's going on. So being able to do that kind of algebra, by the way, is very good in a finance class. It will come in handy. It will serve you well. So R equals D one over P zero plus G. We've got D one. We got P zero and we got G we can solve. So let's solve for R. D one is four divided by P zero, which is 50. I said 50. I wrote 40. I don't know what happened there. Plus G there's nothing worse in my video making career than when I say the right thing and I write the wrong thing and I get the answer wrong. I have to redo the video. Okay. Four divided by 50, it's going to be 8.08. So I get 8% plus 5% equals 13%. Our equity cost of capital is 13%. Now that gets deconstructed. And the reason I did the formula this way, or I rearranged the formula in the way I did is because it says calculate the dividend yield. We've calculated it. It's the dividend D one over P zero. Uh, that's the dividend yields for, you know, I'm getting a $4 dividend. If I invest $50 today, I got a $4 dividend. My dividend yield is 8%. So our dividend yield is 8%. What's the other 5% and the other 5% is our capital gains. It's, it's how much we're, uh, expecting or requiring capital gains growth in, in the stock value. So, uh, it sort of deconstructs into two pieces here, but the answer to the second part, what's our dividend yield, our dividend yield is 8%. And again, the other component here is, uh, capital gain, you know, how, how we expect the, um, stock price to grow. So that's that 5%. Okay. There we have it. We've solved. What is this? Five, two, eight. Thanks so much for watching. Bye-bye. See Okay. I found it. Goodbye.