Question

Here are forecasts for next year for two stocks:

	Stock A			Stock B
Return on equity		12	%		10	%
Earnings per share	$	4.00		$	3.50
Dividends per share	$	3.00		$	3.00

a. What are the dividend payout ratios for each firm? (Do not round intermediate calculations. Enter your answers as a percent rounded to the nearest whole number.)

	payout ratio %
Stock A
Stock B

b. What are the expected dividend growth rates for each stock? Assume dividend has a steady growth for both stocks. (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places.)

	growth rate %
Stock A
Stock B

c. If investors require a return of 12% on each stock, what are their values? (Do not round intermediate calculations. Round final answers to 2 decimal places.)

	PV
Stock A
Stock B

Answer 1

1. Dividend Payout ratio=Dividend per share/Earnings per share

Stock A Dividend Payout ratio=3/4=75%

Stock B Dividend Payout ratio=3/3.5=85.7%

2. growth rate=retention ratio*Return on Equity

retention ratio=1-dividend payout ratio

Stock A retention ratio=1-dividend payout ratio=1-75%=25%

Stock B retention ratio=1-dividend payout ratio=1-85.7%=14.3%

growth rate of Stock A=retention ratio*Return on Equity=25%*12%=3%

growth rate of Stock B=retention ratio*Return on Equity=14.3%*10%=1.43%

3. Present value=Dividend per share/(required return-growth rate)

Present value of Stock A=3/(12%-3%)=$33.33

Present value of Stock B=3/(12%-1.43%)=$28.38