Your company had net income of $102,500 for the year just ended. Dividends of $55,250 were paid on the company's beginning equity of $1,127,500. If the company has 78,000 common shares outstanding with a current market price of $9.50 per share, what is the required rate of return on the shares assuming a constant sustainable growth rate of dividends?
11.66% 

11.96% 

12.26% 

12.56% 

12.86% 
Given about a company,
Net income = $102500
Dividends = $55250
Equity = $1127500
Number of shares outstanding = 78000
Current market price of share P0 = $9.5
So, dividend per share D0 = Dividend/number of shares = 55250/78000 = $0.71
Return on equity ROE = Net income/equity = 102500/1127500 = 9.09%
Plowback ratio b = (Net income  Dividend)/net income = (102500  55250)/102500 = 46%
So, sustainable growth rate of the firm g = b*ROE = 0.46*0.0909 = 4.19%
Using constant dividend growth model, rate of return on investment Ke is
Ke = g + D0*(1+g)/P0 = 0.0419 + 0.71*(1 + 0.0419)/9.5 = 11.96%
So, required rate of return on shares = 11.96%
Option B is correct.
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