IBM's stock price is $22, it is expected to pay a $2 dividend, and analysts expect the firm to grow at 10% per year for the next 5 years. TDI's stock price is $10, it is expected to pay a $1 dividend, and analysts expect the firm to grow at 12% per year for the next 5 years. What is the difference in the two firms' required rate of returns?
A) 2.91%
B) 1.82%
C) 2.03%
D) 3.23%

Question

Quizplus · Accepted Answer

The required rate of return can be calculated using the Gordon Growth Model: Required Return = (Dividend/Price) + Growth Rate. For IBM: (2/22) + 0.10 = 0.1909 or 19.09%. For TDI: (1/10) + 0.12 = 0.22 or 22%. The difference is 22% - 19.09% = 2.91%.

IBM's Stock Price Is $22, It Is Expected to Pay