Question

In the past year, the Canadian Company paid $38,100 in dividends on the company's equity of $1,587,500. The company had net earnings of $127,000 with an ROE of 8%. If the company has 100,000 shares outstanding with a current market price of $11.0625 per share, what is the required rate of return?

Answer 1

Dividend payout ratio = Dividend paid / Net income

Dividend payout ratio = $38,100 / $127,000

Dividend payout ratio = 30%

Retention ratio = 1 - Dividend payout ratio

Retention ratio = 1 - 30%

Retention ratio = 70%

Growth rate = Retention ratio * Return on Equity

Growth rate = 70% * 8%

Growth rate = 5.6%

Dividend per share = Dividend paid / Shares outstanding

Dividend per share = $38,100 / 100,000

Dividend per share = $0.381

Current market price = Dividend per share * (1 + growth rate) / (Required rate of return - growth rate)

$11.0625 = $0.381 * (1 + 5.6%) / (Required rate of return - 5.6%)

Required rate of return = ($0.381 * (1 + 5.6%) / $11.0625) + 5.6%

Required rate of return = 9.24%