Question

​(Common stock valuation​) Dalton Inc. has a return on equity of

11.6 percent and retains

57 percent of its earnings for reinvestment purposes. It recently paid a dividend of ​$

3.50 and the stock is currently selling for ​$

39.

a. What is the growth rate for Dalton​ Inc.?

b. What is the expected return for​ Dalton's stock?

c. If you require a

13 percent​ return, should you invest in the​ firm?

​% ​ (Round to two decimal​ places.)

Answer 1

Return on Equity(ROE) = 11.6%

Retention ratio(b) = 57%

a). Growth rate for Dalton Inc. = ROE*b

= 11.6%*0.57

= 6.612%

Growth rate for Dalton Inc. = 6.61%

b). Calculating Expected Return(Ke) of dalton Inc.:-

where, D0 = Dividend just paid = $3.50

g = grwoth rate = 6.612%

P0 = Current Price= $39

Ke = 16.18%

Expected Return(Ke) of dalton Inc is 16.18%

c). If Required return(ke) of Investor is 13%

calculating the price of Share based on Required Return:-

where, D0 = Dividend just paid = $3.50

g = grwoth rate = 6.612%

P0 = Current Price

P0 = $58.41

As based on Required return(ke) of Investor Price of Stock is $58.41 while it is Currently selling for $39. As the Stock is undervalued it should be Invested In