Walter Utilities is a dividend-paying company and is expected to pay an annual dividend of $1.45 at the end of the year. Its dividend is expected to grow at a constant rate of 9.00% per year. If Walter's stock currently trades for $21.00 per share, what is the expected rate of return

The expected rate of return on the stock is 15.90%

Explanation:

The price of a stock that is expected to pay a dividend that grows at a constant rate forever can be calculated using the constant growth model of Dividend discount model (DDM) approach. The DDM values a stock based on the present value of the expected future dividends. The formula for price today under this model is,

P0 = D1 / r - g

Where,

D1 is the expected dividend for the next period r is the required rate of return g is the growth rate in dividends

We already know the D1, the price today and the growth rate. Plugging in these values in the formula, we can calculate the expected rate of return.

21 = 1.45 / (r - 0.09)

21 * (r - 0.09) = 1.45

21r - 1.89 = 1.45

21r = 1.45 + 1.89

r = 3.34 / 21

r = 0.1590 or 15.90%