Required Rate of Return

Practice Question

Intro to Finance
Equity Valuation
Required Rate of Return
Short Answer

You are considering acquiring a common stock that you would like to hold for one year. You expect to receive both $1.25 in dividends and $32 from the sale of the stock at the end of the year. The maximum price you would pay for the stock today is _____ if you wanted to earn a 10% return.

Answer +
Final Answer: $30.23
Explanation +

Step-by-Step Explanation:

  1. Define the variables:
    Dividend (D₁) = $1.25
    Sale price at year-end (P₁) = $32
    Required return (r) = 10% or 0.10
  2. Apply the present value formula:
    \( P_0 = \frac{D_1 + P_1}{1 + r} = \frac{1.25 + 32}{1.10} = \frac{33.25}{1.10} \approx 30.23 \)
  3. Conclusion: The most you would pay for the stock today to earn a 10% return is $30.23.