Question

Sidman Products's common stock currently sells for $57 a share. The firm is expected to earn $5.70 per share this year and to pay a year-end dividend of $3.90, and it finances only with common equity.

A. If investors require a 10% return, what is the expected growth rate? Round your answer to two decimal places. Do not round your intermediate calculations. %

B. If Sidman reinvests retained earnings in projects whose average return is equal to the stock's expected rate of return, what will be next year's EPS? (Hint: g = (1 – Payout ratio)ROE). Round your answer to the nearest cent. Do not round your intermediate calculations. $ per share

Answer 1

Solution a) Using Gordon Growth Model, Rs = D1/P + g

where Rs = Required rate of return = 10%

D1 = Expected Dividend = $3.90

P = Current Stock Price = $57

g = Expected growth rate

Therefore, 10% = 3.90/57 + g

g = 10% - 3.90/57

g = 10% - 6.8421053%

g = 3.157894%

g = 3.16%

Solution b) Stock Price for Next Year

P1= P0*(1 + g) = $57*(1 + 3.157894%)= $58.80

Earnings Per Share = Price(P1)*Returns On Stock (Rs)

= $58.80 * 0.10

= $5.88

Therefore, next year’s EPS will be $5.88.

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