Macrosoft paid a dividend of $10 per share today (i. e., D₀=$10). The dividends are anticipated to maintain a 10 percent growth rate per year forever. The next dividends will be paid one year from today. If the Macrosoft stock currently sells for $100, what is the required rate of return on the Macrosoft stock?

The required rate of return on Microsoft stock is 21%.

Explanation:

The constant growth model of Dividend Discount Model approach is used to calculate the price or value of a firm whose dividend growth rate is constant. The formula for price today under this model is,

P0 = D0 * (1+g) / r - g

Where,

D0 * (1+g) is the dividend expected for the next period of D1 r is the required rate of return g is the growth rate in dividends

As we know the D0, the price today and the growth rate, we can plug in these values in the formula to calculate the required rate of return (r).

100 = 10 * (1+0.1) / (r - 0.1)

100 * (r - 0.1) = 11

100r - 10 = 11

100r = 11+10

r = 21 / 100

r = 0.21 or 21%