Chartered Financial Analyst Level 1

Chartered Financial Analyst Level 1

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An analyst gathers the following information about a company's stock:

  • Current dividend per share (D₀): $4
  • Current EPS: $5
  • Dividend growth rate: 4% If the estimated stock value using the Gordon growth model is $92 per share, the required return on this stock is closest to:

Explanation:

Explanation

The Gordon growth model formula is:

V0=D1r−gV_0 = \frac{D_1}{r - g}

Where:

  • V0V_0 is the current stock value ($92).
  • D1D_1 is the next year's dividend, calculated as D0×(1+g)D_0 \times (1 + g).
  • rr is the required return.
  • gg is the dividend growth rate (4%).

To solve for rr, rearrange the formula:

r=D1V0+gr = \frac{D_1}{V_0} + g

Substitute the given values:

D1=4×(1+0.04)=4.16D_1 = 4 \times (1 + 0.04) = 4.16 r=4.1692+0.04=0.0452+0.04=0.0852 or 8.52%r = \frac{4.16}{92} + 0.04 = 0.0452 + 0.04 = 0.0852 \text{ or } 8.52\%

Why the other options are incorrect:

  • Option A (8.35%): Incorrectly uses D0D_0 instead of D1D_1.
  • Option C (9.44%): Incorrectly uses E0E_0 (current EPS) instead of D1D_1.
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