,,Gremlin Industries will pay a dividend of S1.85 per share this year. It is exp

Question

,,Gremlin Industries will pay a dividend of S1.85 per share this year. It is expected that this dividend is. will grow by 4% per year each year in the future. The current price of Gremlin's stock is $23.90 per share. What is Gremlin's equity cost of capital? - A) 16% B) 11% C)14% D) 12% 19, Jumbo Transport, an air-cargo company, expects to have earnings per share of $2.75 in the coming 19) year. It decides to retain 20% of these earnings in order to lease new aircraft. The return on this investment will be 25% If its equity cost of capital is l 1%, what is the expected share price of Jumbo Transport? A) $25.67 B) $29.34 C) $22.00 D) $36,67

Explanation / Answer

(18)

Using Dividend growth model, we know that

Cost of Equity Ke= D1/P0 + g

Here

Current dividend, D0 = $1.85, and growth rate g = 4%

So dividend at the end of 1st year = $1.85 x 1.04 = $1.92

Current Price, P0 = $23.90

So, Ke = 1.92/23.9 + 0.04 = 0.1203 or 12.03%

(19)

Earnings per share = $2.75

20% of this is retained, so

Dividend per share, D1 = $2.75 x 0.80 = $2.2

Hence, retained earnings = $2.75 - $2.2 = $0.55

Return on this investment = 25%

So, Growth rate, g = 0.2 x 0.25 = 0.05 or 5%

From dividend growth model,

P0 = D1 / (Ke - g)

      = $2.2/ (0.11- 0.05) = $36.6667  

Related Questions

Navigate

• Browse (All)
• Browse #
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.