QUESTION 9 Christie Company earned $1.42 million for the fiscal year ending yest

Question

QUESTION 9 Christie Company earned $1.42 million for the fiscal year ending yesterday. The firm also paid out 35 percent of its earnings as dividends yesterday. The firm will continue to pay out 35 percent of its earnings as annual, end-of-year dividends. The remaining 65 percent of earnings is retained by the company for use in projects. The company has 4 million shares of common stock outstanding. The current stock price is $28. The historical return on equity (ROE) of 14 percent is expected to continue in the future. What is the required rate of return on the stock? (Hint: use the retention ratio and ROE to estimate the growth rate) 9.72% 9.96% 9.58% 8.75% 8.47%

Explanation / Answer

We'll first find the growth rate (g) of the stock.

Growth rate = Retention ratio x ROE = 0.65 x 0.14 = 0.091

Dividend paid = 1.42 million x 0.35 = $497,000

We know the formula for the stock price

C = Return annually = Dividend paid = 497,000 million

Per share return = 497000/4000000 = $0.12425

Market price of stock = C/(R-g)

28 = 0.12425/(R-0.091)

R-0.091 = 0.0044375

R = 0.0954 = 9.54%

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