Question

Jupiter Satellite Corporation earned $19.6 million for the fiscal year ending yesterday. The firm also paid out 30 percent of its earnings as dividends yesterday. The firm will continue to pay out 30 percent of its earnings as annual, end-of-year dividends. The remaining 70 percent of earnings is retained by the company for use in projects. The company has 2.8 million shares of common stock outstanding. The current stock price is $84. The historical return on equity (ROE) of 14 percent is expected to continue in the future. What is the required rate of return on the stock?

Answer 1

Current Earnings per share, EPS0 = Current Earnings / Number of shares outstanding
Current Earnings per share, EPS0 = $19,600,000 / 2,800,000
Current Earnings per share, EPS0 = $7.00

Payout Ratio = 30%

Current Dividends per share, D0 = EPS0 * Payout Ratio
Current Dividends per share, D0 = $7.00 * 30%
Current Dividends per share, D0 = $2.10

Retention Ratio, b = 1 - Payout Ratio
Retention Ratio, b = 1 - 0.30
Retention Ratio, b = 0.70

Growth Rate, g = ROE * b
Growth Rate, g = 14.00% * 0.70
Growth Rate, g = 9.80%

Expected Dividends per share, D1 = D0 * (1 + g)
Expected Dividends per share, D1 = $2.10 * 1.098
Expected Dividends per share, D1 = $2.3058

Current Price per share, P0 = $84.00

Required Rate of Return = D1 / P0 + g
Required Rate of Return = $2.3058 / $84.00 + 0.0980
Required Rate of Return = 0.1255 or 12.55%