Question

Laurel Enterprises expects earnings next year of ​$3.84 per share and has a 50 % retention​ rate, which it plans to keep constant. Its equity cost of capital is 11 %​, which is also its expected return on new investment. Its earnings are expected to grow forever at a rate of 5.5 % per year. If its next dividend is due in one​ year, what do you estimate the​ firm's current stock price to​ be?

Answer 1

Next dividend payment= Next earnings per share*dividend payout ratio

= $3.84*(1 - 0.50)

= $3.84*0.50

= $1.92 per share

Growth rate= Retention rate*Return on new investment

= 0.50*0.11

= 0.0550

The firm's current stock is solved using the dividend discount model.

Price of the stock today=D1/(r-g)

where:

D1=next dividend payment

r=interest rate

g=firm’s expected growth rate

Current stock price= $1.92/ (0.11 - 0.055)

= $1.92/ 0.055

= $34.9091 $34.91.

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