Stock Price Growth Rate Analysis

What is the growth rate expectation for Merck based on the given data?

Assuming investors expect Merck to grow at a constant rate in perpetuity, what is that growth rate expectation?

Answer:

The growth rate expectation for Merck based on the given data is 0.019.

Merck, a renowned company, has recently paid an annual dividend of $2.4 in 2019. Upon looking up their beta, it was found to be 0.37, indicating that the company is less risky than the market portfolio. With a current risk-free rate of 1.54% and a market risk premium of 7.5%, investors are eager to know what the growth rate expectation for Merck is.

To calculate the growth rate expectation, we can utilize the Gordon Growth Model. The formula for this model is as follows:

Stock Price = Dividend / (Required Return - Growth Rate)

By plugging in the given values:

$79 = $2.4 / (r - g)

Where:

r = 1.54% + 7.5% x 0.37 = 4.9075% (required return)

g = growth rate expectation (unknown)

After solving for 'g', we find that:

g = r - ($2.4 / $79) = 4.9075% - 3.03797% = 1.8695% or 0.019

Therefore, the growth rate expectation for Merck is 0.019 (rounded to three decimal places).