Question

Rick’s Department Stores has had the following pattern of earnings per share over the last five years:  

Year	Earnings per share
20XU	$	12.00
20XV		12.60
20XW		13.23
20XX		13.89
20XY		14.58

The earnings per share have grown at a constant rate (on a rounded basis) and will continue to do so in the future. Dividends represent 40 percent of earnings.

  

a. Project earnings and dividends for the next year (20XZ). (Do not round intermediate calculations. Round the final answers to 2 decimal places.)

  

	20XZ
Earnings	$
Dividend	$

  

b. If the required rate of return is 13 percent, what is the anticipated share price at the beginning of 20XZ? (Do not round intermediate calculations. Round the final answer to 2 decimal places.)

  

Anticipated stock price           $

Answer 1

Constant growth rate (rounded)= 5% as follows:

Part (a):

Earnings for next year (20XZ)= Last EPS*(1+Growth rate)= $14.58*1.05= 15.309 rounded to $15.31

Given, payout ratio=40%

Dividend for year 20XZ = EPS*Payout ratio= 15.309*40%= 6.1236 rounded to $6.12

Part (b):

Anticipated share price at the beginning of year 20XZ= D1/(r-g)

Where D1= Dividend for year 20XZ, r- required rate of return (given as 13%) and g= constant growth rate (5%)

Share price at the beginning of year 20XZ= 6.1236/(0.13-0.05) = $76.55