Question

The KJ Corporation has averaged an ROE of							11%	over
the past 5 years and that should continue into the
future.  The firm has a payout ratio of							80%	on
earnings per share of				$10.66	and paid the dividend
yesterday. The discount rate for a firm of KJ's
risk level is			12%
a)	What is the expected Growth Rate of KJ's dividend? (note: round to the nearest 100th of a percent) (1 mark)
b)	What is KJ's current stock price?               (note: round to the nearest cent) (1 mark)

Answer 1

(a)-The expected Growth Rate of KJ's dividend

The expected Growth Rate of KJ's dividend = Return on equity x Retention ratio

= Return on equity x (1 – Dividend payout ratio)

= 11.00% x (1 – 0.80)

= 11.00% x 0.20

= 2.20%

(b)-KJ's current stock price

Here, we’ve the Dividend per share in Year 0 (D0) = $8.5280 per share [$10.66 x 80%]

Required Rate of Return (Ke) = 12.00%

Dividend Growth Rate (g) = 2.20% per year

Current selling price of the stock (P0) = ?

As per Constant Growth Dividend Valuation Model, the Current Price of the common stock is calculated as follows

The Current price of the stock = D0(1 + g) / (Ke – g)

= $8.5280(1 + 0.0220) / (0.12 – 0.0220)

= $8.7156 / 0.0980

= $88.93 per share