Question

Questrom Corp will have earnings per share of $60 this year and expect that they will pay out $15 of these earnings to shareholders in the form of a dividend. Questrom’s stock is currently trading for $125.00 and their equity cost of capital is 20%. What return must the company be earning on its new investments?

Can someone show me step by step how you arrived at 10.67% ?

Answer 1

The rate is computed as shown below:

retention rate is computed as follows:

= (Earnings - dividend) / Earnings

= ($ 60 - $ 15) / $ 60

= 75% or 0.75

growth rate is computed as follows:

= cost of capital - Dividend / current price

= 0.20 - $ 15 / $ 125

= 8% or 0.08

So, the return will be as follows:

= growth rate / retention rate

= 0.08 / 0.75

= 10.67% Approximately

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