Question

22.Current price of a stock is $50 per share. It is expected to earn $4 per share. The company will retain 40

percent of its income. If company’s discount rate is 9 percent, the expected growth rate is:

a. 9.5% b. 4.8%

c. 4.2% d. None of the above

Answer 1

Calculation of the expected growth rate :-

Here

market price of share = $ 50 per share

expected EPS = $ 4 per share

retaining ratio = 40% i.e, Payout ratio = 100% - retaining ratio

Dividend pay out ratio = 60 % (100 - 40)

Expected dividend = 4 *60% = $ 2.4 per share

Discount rate = 9%

here discount rate means cost of equity

formula

Ke =( D1 / P0) + g

D1 = expeced dividend = $2.4 per share.

P0 = market price of share. = $ 50

g= growth rate

9% = (2.4 / 50 ) + g

0.09 = 0.048 + g

g = 0.09 - 0.048 = 0.042

growth rate = 4.2%

option c is correct.