Question

1) If a $24 per share stock had P/E ratio of 12 and pays out 40% of its profits in dividends,

(a) how large is the dividend

(b) what is the implied rate of return

2) What is the current yield on a $1,000 bond, with 5% coupon if its market price is $900.

Answer 1

P/E = 12

P = $24

P/E = 12

E = 24/12 = 2

That means Earning Per Share is $2

a)

Payout ratio = Dividend per share/Earning per share

40% = Dividend per share/Earning per share

Hence, Dividend per share = 40% of Earning per share = 40% * 2 = $0.8

Hence, the dividend is $0.80 per share

b) Under earnings-based approach, the implied rate of return is: (Dividend per share/Price per share) = $0.8/$2 = 40%

c)

Face Value of Bond = $1000

Coupon rate = 5%

Market Price = $900

Current yield is Current Yield = Annual Coupon/Current Bond Price = 5%*$1000/$900 = $50/$900

Hence, current yield = 5.56%