7. A company just reported earnings per share of $10.00 paid a dividend of $6.00

Question

7. A company just reported earnings per share of $10.00 paid a dividend of $6.00 a share. Based on the company's risk, shareholders require a return of 9% on its stock. You believe the stock's earnings and dividends will grow 4% a year indefinitely. a. What would you expect the stock s price to be currant? b. What would you expect the stock's price to be one year from now? If you buy the stock for the price you determined in part (a), hold it for one year and then sell it for the price you determined in part (b), will you earn a 9% return? Explain. c.

Explanation / Answer

a. Stock price per share = 6*1.04/(0.09-0.04)

stock price per share = 124.80

b. price in one year = 124.80*1.04 = 129.79

c. return = (129.79 + 6*1.04)/124.80 - 1 = 9.00%

so including the dividend earned, the share will earned the required 9%

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