Eastern Electric currently pays a dividend of about $1.76 per share and sells fo

Question

Eastern Electric currently pays a dividend of about $1.76 per share and sells for $26 a share.

a. If investors believe the growth rate of dividends is 5% per year, what rate of return do they expect to earn on the stock? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.) Rate of return %

b. If investors' required rate of return is 12%, what must be the growth rate they expect of the firm? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.) Growth rate %

c. If the sustainable growth rate is 6% and the plowback ratio is .4, what must be the rate of return earned by the firm on its new investments? (Enter your answer as a percent rounded to 2 decimal places.) Rate of return %

Explanation / Answer

If investors believe the growth rate of dividends is 5% per year, what rate of return do they expect to earn on the stock? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.) Rate of return %

R = DIV 1 / P0 + g

= [($1.76 * 1.05)/26] + 0.05 = 0.0926 = 12.11%

If investors' required rate of return is 12%, what must be the growth rate they expect of the firm?

If r= 0.12

.12 =(1.76*(1+g))/26 +g

g=4.90%

if the sustainable growth rate is 6% and the plowback ratio is .4, what must be the rate of return earned by the firm on its new investments?

g= return on equity * plowback ratio

6% =return on equity * .40

return on equity=6%/.40 =15%

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