Question

Your company had net income of $102,500 for the year just ended. Dividends of $55,250 were...

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%
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Answer #1

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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