Question

1. A stock just paid a dividend of $4.73 and is expected to maintain a constant dividend growth rate of 4.6 percent indefinitely. If the current stock price is $84, what is the required return on the stock?

2. Gnomes R Us just paid a dividend of $1.95 per share. The company has a dividend payout ratio of 55 percent. If the PE ratio is 17.4 times, what is the stock price?

Answer 1

1.) current price = next year dividend / (required rate - growth rate)

$84 = $4.73 * (1 + 0.046) / (required rate - 0.046)

84 = 4.94758 / (required rate - 0.046)

84 * (required rate - 0.046) = 4.94758

84 * required rate - 3.864 = 4.94758

84 * required rate = 8.81158

required rate = 10.49%

2.) dividend payout ratio = dividend per share / earning per share

0.55 = $1.95 / earning per share

  earning per share = $3.55 per share

    PE ratio = stock price /  earning per share

   17.4 = stock price / $3.55

   Stock price = $61.77