A stock sells for $40. The next dividend will be $4 per share. If the rate of re
ID: 2739934 • Letter: A
Question
A stock sells for $40. The next dividend will be $4 per share. If the rate of return earned on reinvested funds is a constant 10% and the company reinvests 40% of earnings in the firm, what must be the discount rate? (Do not round intermediate calculations. Enter your answer as a whole percent.) Discount rate?
If investors believe the growth rate of dividends is 4% 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%
If investors' required rate of return is 10%, 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%
If the sustainable growth rate is 5% and the plowback ratio is .5, what must be the rate of return earned by the firm on its new investments?
Rate of Return%
a.If investors believe the growth rate of dividends is 4% 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 10%, 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 5% and the plowback ratio is .5, what must be the rate of return earned by the firm on its new investments?
Rate of Return%
Explanation / Answer
Answer a.
Using Constant-growth model, stock price P(0) = Div(1)/(r-g)
where g = rate of return on reinvested fund*retention rate = 0.10*0.40 =0.04
Hence we have, 40 = 4/(r - 0.04)
Discount rate r = 4/40 + 0.04 = 0.14 = 14%
Answer b.
P0 = D1/(r-g)
40 = 4 / (0.10 - g)
g = 0%
Answer c.
Growh rate = return on equity * plowback ratio
0.05 = return on equity * 0.5
return on equity = 0.1
return on equity = 10%
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