Question

Teradyne earned $10.05 million for the fiscal year ending yesterday. The firm also paid out 30 percent of its earnings as dividends yesterday. The firm will continue to pay out 30 percent of its earnings as annual, end-of-year dividends. The remaining 70 percent of earnings is retained by the company for use in projects. The company has 2.4 million shares of common stock outstanding. The current stock price is $50. The historical return on equity (ROE) of 15 percent is expected to continue in the future. What is the required rate of return on the stock? (Hint: use the retention ratio and ROE to estimate the growth rate)

Answer 1

Net Income = $10.05 million
Number of shares outstanding = 2.40 million
Payout Ratio = 30%

Dividends = Net Income * Payout Ratio
Dividends = $10.05 million * 30%
Dividends = $3.015 million

Dividend per share = Dividends / Number of shares outstanding
Dividend per share = $3.015 million / 2.40 million
Dividend per share = $1.25625

Retention Ratio = 70%
ROE = 15%

Growth Rate = ROE * Retention Ratio
Growth Rate = 15% * 0.70
Growth Rate = 10.50%

Expected Dividend per share = Dividend per share * (1 + Growth Rate)
Expected Dividend per share = $1.25625 * 1.1050
Expected Dividend per share = $1.38816

Required Rate of Return = Expected Dividend per share / Current Price + Growth Rate
Required Rate of Return = $1.38816 / $50.00 + 0.1050
Required Rate of Return = 0.1328 or 13.28%