Calculating Expected Growth Rate for Merck Stock
Understanding the Calculation Process
The calculation of the expected growth rate for Merck stock involves using the constant growth rate formula, which considers various financial metrics to determine the growth rate that investors anticipate for the company's stock.
The formula used to calculate the expected growth rate is:
Stock price = Dividend / (Required rate of return - Growth rate)
Given Financial Data:
1. Required Rate of Return: The required rate of return is calculated as the sum of the risk-free rate and the product of Merck's beta and the market risk premium. 2. Stock Price: The current stock price for Merck is $79. 3. Dividend: Merck's annual dividend payment is $1.7. 4. Beta: Merck's beta is 0.34, indicating a lower risk compared to the market portfolio.Calculating the Expected Growth Rate:
Based on the formula provided and the given financial data, we can calculate the expected growth rate as follows:
1. Calculate Required Rate of Return:Required rate of return = Risk-free rate + Beta * Market risk premium
Required rate of return = 2.04% + 0.34 * 11.5% = 5.59%
2. Plug in Values:Stock price = $79
Dividend = $1.7
Required rate of return = 5.59%
3. Use the Constant Growth Rate Formula:$79 = $1.7 / (0.0559 - Growth rate)
$79(0.0559 - Growth rate) = $1.7
$4.4081 - $79Growth rate = $1.7
Growth rate = $1.7 / $2.7081 = $79
4. Determine the Growth Rate:Growth rate = $2.7081 / $79 = 0.0343 or 3.43%
Therefore, based on the calculations using the constant growth rate formula, the expected growth rate for Merck stock is 0.0343, which represents a growth expectation of 3.43% for investors.