Question

a firm has book equiyy og 100, payout ratio of 40 % roe 10% constant. instrumrnus with same risk expected to pay 15%.

assuming Roe and payout remain constant what is the expexted total dividend next year ?

what should the market value of equity be?

Answer 1

Book equity = $100

ROE = 10%

Net income = Book equity * ROE

100*10%

= $10

Payout ratio = 40%

Retention ratio = 1-40% = 60%

So, dividends paid this year = net income * payout ratio

10*40%

=$4

Return on same risk or ke = 15%

Growth rate = retention ratio * return on equity

60%*10%

=6%

Expected Dividend next year = D0*(1+g)

4"(1+6%)

4.24

So, Expected Dividend next year is $4.24

Market price = Dividends next year/(ke - g)

4.24/(15% - 6%)

47.111111111111

So Market price of share is $47.11