Eastern Electric currently pays a dividend of about $171 per share and sells for

Question

Eastern Electric currently pays a dividend of about $171 per share and sells for $34 a share. a. If investors believe the growth rate of dividends is 4% per year, what rate ofret rnd they expect to earn on the stock? (Do not round Intermediate calculations. Round your answer to 2 decimal places.) te 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. Round your answer to 2 decimal places.) Growth rate c. If the sustainable growth rate is 3% and the plowback ratio is .6, what must be the rate of return earned by the firm on its new investments? (Round your answer to 2 decimal places.) Rate of return 1.11 %

Explanation / Answer

A. Rate of Return-

P0 = DPS0 ( 1 + G ) / ( Ke - G )

$34 = $1.71 ( 1 + 0.04) / ( Ke - 4% )

$34 / $1.7784 = 1 / ( Ke - 4% )

$19.12 (Ke - 0.04) = 1

$19.12Ke - 0.7647 = 1

Ke = 9.23%

B. Growth Rate -

P0 = DPS0 ( 1 + G ) / ( Ke - G )

$34 = $1.71 ( 1 + G )/ ( 10 - G )

$3.4 - 34G = 1.71 + $1.71G

1.69 = 35.71G

Ke = 4.73% (approx)

C. Let First we calculate DPS-

DPS = $1.71 * ( 1 - 0.6 )

DPS = $0.684

Now, Required Rate of return -

P0 = DPS1 / ( Ke - G )

$34 = $0.684 / ( Ke - 3% )

$34 / $0.684 = 1 / ( Ke - 3% )

$49.71 (Ke - 0.03) = 1

$49.71Ke - 1.49 = 1

Ke = 5%

Thanks

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