Question

Jupiter Satellite Corporation earned $19.2 million for the fiscal year ending yesterday. The firm also paid out 40 percent of its earnings as dividends yesterday. The firm will continue to pay out 40 percent of its earnings as annual, end-of-year dividends. The remaining 60 percent of earnings is retained by the company for use in projects. The company has 3.2 million shares of common stock outstanding. The current stock price is $85. The historical return on equity (ROE) of 16 percent is expected to continue in the future. What is the required rate of return on the stock? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Rate of return:

Answer 1

For a constant dividend growing model

Price of stock = dividend for next year / (cost of equity - growth rate)

Where growth rate = (1- dividend payout ratio) * return on equity

Given dividend payout ratio =40%

And return on equity =16%

Hence growth rate =(1-40%)*16%=60%*16*=9.6%

Also dividend for next year = dividend per share for current year *(1+ growth rate)

Given earning for current year =19.2 million

Dividend paid out =40%*19.2 million =7.68 million

Number of shares =3.2 million shares

Hence dividend per share for current year =dividend / shares

=7.68/3.2

=2.4/ share

Hence dividend for next year. =2.4*(1+9.6%)

=2.6304

Given price of stock =85

Hence,

85=2.6304/(cost of equity - 9.6%)

Cost of equity - 9.6%=2.6304/85

Cost of equity =3.09458%+9.6%

=12.69458%

Hence the required rate of return= cost of equity =12.69458%