Question

Your firm just recently announced EPS of $10 and sells for $150 per share. The firm...

Your firm just recently announced EPS of $10 and sells for $150 per share. The firm has a Net Profit Margin of 6%, Total Asset turnover of 1.0x, and a Debt/Equity ratio of 0.5. It pays out 60% of its earnings as dividends. What is the required return on the firm’s equity?

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Answer #1
Equity multiplier = 1 + Debt equity ratio = 1 + 0.5 = 1.5
Return on equity (ROE) = Net profit margin * Total asset turnover * Equity multiplier = 6% * 1 * 1.5 = 9%
Growth (g) = ROE * (1-Dividend payout ratio) = 9% * (1-60%) = 3.60%
Dividend (D0) = EPS0 * Dividend payout ratio = 10 * 60% = 6
Price per share = D0*(1+g)/(Ke-g)
150 = 6*(1+3.60%)/(Ke-3.60%)
150 = 6.216/(Ke-3.60%)
Ke = (6.216/150) + 3.60% = 7.74%
required return on the firm’s equity = 7.74%
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