Equity selling, recently, return, percent

mfleming1983

QUESTION -- ROE is 16 percent and 40 percent of earning is paid out in dividends. If the firm recently paid 1.50 dividend and stock is selling for 40 what is the reqd rate of return if its priced according to ddm?

ANSWER---
g--9.6 percent

k ---1.5*1.096/40 + .096

Someone pls tell me what the formula used above is ???

sgupta0827

Gordon Growth model

p0=d1/(r-g)

g=b*roe (b=Retention Ratio)
ROE=Return on Equity

40% earning is paid out as dividends, so 60% is retained.
g=60% * ROE = 60%*16% = 9.6%

D1=D0(1+g)=1.5*1.096
r = D1/P0 + g
=1.5*1.096/40 + 0.096

CP