Question

Please show all steps so that I can understand the methodology behind solving this problem.

The most recent net income for John Doe Industries was $3 million. $1.8 million of these earnings were paid out as dividends. John Doe's total equity is $20 million with 1 million shares outstanding. Their cost of equity is 12.5%.

What is the expected growth rate for this company's dividends? What is the value of a share of the company's stock?

Answer 1

Last Year:

Payout Ratio = Dividend / Net Income
Payout Ratio = $1.80 million / $3.00 million
Payout Ratio = 0.60

Retention Ratio = 1 - Payout Ratio
Retention Ratio = 1 - 0.60
Retention Ratio = 0.40

Dividend per share = Dividend / Number of shares outstanding
Dividend per share = $1.80 million / 1.00 million
Dividend per share = $1.80

Return on Equity = Net Income / Total Equity
Return on Equity = $3.00 million / $20.00 million
Return on Equity = 15%

Growth Rate = Return on Equity * Retention Ratio
Growth Rate = 15% * 0.40
Growth Rate = 6%

Dividend per share, Next Year = Dividend per share, Last Year * (1 + Growth Rate)
Dividend per share, Next Year = $1.80 * 1.06
Dividend per share, Next Year = $1.908

Value of Share = Dividend per share, Next Year / (Cost of Equity - Growth Rate)
Value of Share = $1.908 / (0.1250 - 0.0600)
Value of Share = $1.908 / 0.0650
Value of Share = $29.35