Question

Assume that you have the following information:- Real rate of interest = 2.0%; Expected Inflation = 3.0%; Required return on the Market = 12.0%; EPS = $2.0; Dividend pay-out ratio = 30.0%; Growth rate in EPS & Dividends per share = 5.0% (constant); Industry P/E multiple is 12; .

Answer the following questions:- 1 - The Required or Expected return on the stock is??? 2 - Next year's dividends per share (D1) is ???? 3 - According to the "Constant Growth" model; the current stock price is ??? 4 - According to the P/E multiple, the stock price is ???

Answer 1

Solutions:

1.Calculation of  Required or Expected return on the stock(ke)

Return on Equity=Growth Rate/Retention Ratio

=0.05/.70

=.07143 or 7.143%

Thus,expected return on equity is 7.143%

b)Next Year Dividend(D1)=EPS*Dividend payout Ratio(1+growth Rate)

=($2*.30)*(1+.05)

=$0.63

Thus D1 is $0.63

c)Calculation of Stock price as per Constant growth model

Stock price=D1/Ke-g

=0.63/7.143%-5%

=$29.40

d)Calculation of stock price P/E multiple

Price of Stock=EPS*P/E multiple

=$2*12

=$24