Juggernaut Satellite Corporation earned $19.6 million for the fiscal year ending

Question

Juggernaut Satellite Corporation earned $19.6 million for the fiscal year ending yesterday. The firm also paid out 30 percent of its earnings as dividends yesterday. The firm will continue to pay out 30 percent of its earnings as annual, end-of-year dividends. The remaining 70 percent of earnings is retained by the company for use in projects. The company has 2.8 million shares of common stock outstanding. The current stock price is $84. 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? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Explanation / Answer

Company is distributing 30% of its earnings as dividends

Therefore, company is retaining = 100-30 = 70% of its earnings

Growth = Retention ratio * ROE = 0.7*0.14 = 9.8%

Earning = 19.6 million

Paid as dividends = 19.6*0.3 = $5.88 million

Number of shares outstanding = 2.8 million

Dividend per share = Total dividends / number of shares outstanding = 5.88/2.8 = $2.1

Current stock price = $84

Using gordan growth model, Price of stock = Current dividend*(1+growth)/(r-growth), where r is required rate of return

84 = 2.1*(1.098)/(r-0.098)

40 = 1.098/(r-0.098)

r - 0.098 = 0.02745

r = 0.02745+0.098 = 0.12545

So required rate of return = 12.55%

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