91Ó°ÊÓ

The required rate of return is the return after providing all premiums relating to inflation and risk. It has three elements – real rate of return, inflation premium, and risk premium.

In the case of common stock, the required rate of return is complex to compute as it has the highest risk element with no maturity value.

But the required rate of return can be computed if there are known two components–

a) Dividend to be gained in the first year

b) Price in the current year

In the case of growth dividend growth rate must also be known.

Thus the required rate of return can be computed with the following formula –

Ke is required rate of return.

D1 is dividend received at the end of first year.

g is growth rate.

${\mathbf{K}}_{\mathbf{e}}\mathbf{=}\frac{{\mathbf{D}}_{\mathbf{1}}}{{\mathbf{P}}_{\mathbf{0}}}\mathbf{+}\mathbf{g}$