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CFA Level I · CFA Level I Exam · Sources of Equity Returns

An analyst estimates the expected return on a stock using the Gordon growth model approach, in which the expected return is the sum of the dividend yield and the dividend growth rate. A company's next-year dividend is expected to be 3.00 per share, the current price is 60.00, and dividends are expected to grow at 4% indefinitely. The expected return is closest to:

The expected return is about 9%. Under the Gordon growth model, the expected return equals the expected dividend yield plus the growth rate: 3.00 divided by 60.00 is 5%, and adding 4% growth gives 9%.

  1. A7%
  2. B9%Correct
  3. C12%

Explanation

Expected return = D1/P0 + g = 3.00/60.00 + 0.04 = 0.05 + 0.04 = 9%. The 7% option uses an incorrect yield and growth combination, and 12% adds growth to a yield wrongly computed.

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