Question

MSFT currently has a required rate of return of 15% and has a dividend which is expected to grow at a constant rate going forward. MSFT pays 70% of its earnings as dividends and earnings are expected to be $10 next year. The current stock price of MSFT is $55.56.

MSFT's return on equity is ____

MSFT's dividend yield is ____

TRUE or FALSE: as the CFO of MSFT, you should decide that MSFT should increase the amount of dividends being paid out to shareholders.

Answer 1

Div1 = 10 * 0.70 = 7

Price = Div1/(r - g)

r - g = Div1/Price

g = r - Div1/Price

g = 0.15 - 7/55.56

g = 0.02401007919

g = 2.401007919%

g = ROE * (1 - Dividend payout ratio)

ROE = g/(1 - Dividend payout ratio)

ROE = 0.02401007919/(1 - 0.70)

ROE = 0.0800335973

MSFT's return on equity = 8.00335973%

MSFT's dividend yield = Div1/Current price

MSFT's dividend yield = 7/55.56

MSFT's dividend yield = 0.1259899208

MSFT's dividend yield = 12.59899208%

TRUE.  As the CFO of MSFT, you should decide that MSFT should increase the amount of dividends being paid out to shareholders.

MSFT has huge amount of cash reserves. There is no project that can yield more than the dividend yeild. The best use of the free cash flow is to distribute to the shareholders in the form of dividends.