For Royal Electric, we know that last year’s dividend was $2, so in year 1 this would remain unchanged. We must determine first the return required to be able to calculate dividends in years 2 and 3. The question states that common stockholders need a return of 12 percent. This can be taken as the required rate (r). The formula for calculating future dividends is D1 = Do x (1 + g), where Do refers to current period’s dividend and g is growth rate.

Using this information , we can calculate values of respective dividends as: Year 1 – $2; Year 2 – $2.10 ($2x(1+0.05)); Year 3 –$2.2025 ($2x(1+0.05)^2).

DDM can be a useful tool to help investors gauge the potential return on an asset under certain conditions. This allows them to make more informed decisions. Understanding such concepts also helps traders to understand the relationship between factors that drive market prices, allowing them to predict future behavior with greater accuracy.