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**

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