Question

Hosmer Enterprises expects to earn $4 per share next year. The firm’s ROE is 10% and its’ plowback ratio is 60%. If the firm’s market capitalization rate is 8%:

Calculate the price if Hosmer Enterprises pays all of its earnings out as a dividend.

Answer 1

Market Capitalization Rate = Expected Cash Flow / Market Value of the asset ------------------(1)

Present Value of Stock = Expected dividend (Cash Flow) / {Cost of equity - growth}

=> {Cost of equity - growth} = Expected dividend (Cash Flow) / Present Value of Stock ---------(2)

On comparison of equation 1 & 2 we get,  { Cost of equity - growth} = Market Capitalization Rate

=> Price of stock = Expected Cash Flow / Market Capitalization Rate = 4/0.08 = $50