Question

The Events Corporation reported earnings of $2 per share last period. Its dividend payout ratio is 60% of earnings. What should an investor pay for this dividend-paying stock if earnings are projected to increase at 8% annually and the investor’s required rate of return is 10%

Answer 1

Answer-

Events Corporation details

Earnings = $ 2 / share
Dividend payout ratio = 60 % = 0.60

Dividend / share ( D(0) ) = $ 2 x 0.60 = $ 1.2

Earnings growth annually = 8 % = 0.08

V(0) = D(1) / ( r -g )
[ V(0) - value of stock today, D(1) - Dividend next year, r - required rate of return, g -growth rate of dividends]
r = required rate of return = 10 % = 0.10
g = growth rate of dividends = 8 % = 0.08

V(0) = D (0) x ( 1 + 0.08 ) / ( 0.1 - 0.08) [ D(0) - $ 1.2 ]

[ Earnings are projected to grow at 8 % annually so the dvidends will also grow by 8 % annually as the dividends are proportinally 60 % of earnings ]

V(0) = $ 1.2 x ( 1.08) / ( 0.1 - 0.08)

V(0) = $ 1.296 / 0.02

V(0) = $ 64.8

Therefore the investor should pay $ 64.8 for the stock today.