Problem 10-12 Calculation of g and EPS Spencer Supplies\'s stock is currently se

Question

Problem 10-12 Calculation of g and EPS Spencer Supplies's stock is currently selling for $60 a share. The firm is expected to earn $5.40 per share this year and to pay a year-end dividend of $3.50. a. If investors require a 9% return, what rate of growth must be expected for Spencer? Round your answer to two decimal places. b. If Spencer reinvests earnings in projects with average returns equal to the stock's expected rate of return, then what will be next year's EPS? (Hint: g = ROE x Retention ratio.) Round your answer to the nearest cent.

Explanation / Answer

a) P = $60

Ke = Required rate of return = 9%

D1 = Expected dividend = $3.50

g = Growth rate = ?

P = D1/Ke-g

$60 = $3.50/0.09 -g

g = 3.17%

b) Earnings per share = $5.40

Retention ratio = 100% as the entire earnings are reinvested

Returns on earnings = Stock's expected rate of return = 9%

Next year EPS = EPS x (1+0.09)

EPS1 = $5.40(1+0.09)

EPS1 = $ 5.886

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