Question

9. a company pays annual dividends as a percentage of annual earnings per share. Last year the companys stock earned $8.00 per share and the dividend payout ratio was 25%.The company just announced expectations that that earnings are to increase by 48 cents per share in the coming year and that they will keep the payout ratio dividends the same as last year at 25% per share. The company also said that future dividends will grow at the same rate on an annual basis into the foreseeable future.

A. if the company expects that investors will require 155 annual return on investments what should it expect its stock price to be according to the constant dividend growth model?

b. given the information above, what is the total return for this stock for an investor who purchases the stock for $22.3o per share exactly one year before the next dividend payout and then sells the stock for $26.25 immediately after receiving the dividend?

Answer 1

1. Expected return on investment = 155

Expected Growth rate = 25%

Stock price as per Constant Dividend Growth Model

I,ePrice = Dividend

Required Rate of return – Expected Growth rate

= 2.12

32.22%-25%

= $29.34 (Approx)

Required rate of return calculation –

Rate of Return = Expected annual Return   =155/481=32.22%

Total Share Value

Total Share Value = No of shares * Share Price=(155/8.48)*26.35 = 481.63

B.

Earnings               $8 Per share

Dividend payout ratio      25%

Dividend $2 per share

Future Earnings $8.48

Dividend in future - $2.12

Sale of Share = 26.35

Purchase of Share = $22.30

Capital gain = $4.05

Divend received for both years = $2 + $2.12 = $4.12

Total return from the share = Capita Gain + Dividend = $4.05+$4.12 = $8.17