Question

1. Omega Company Limited will pay a dividend of KShs. 8 per share at the end of year one. The dividends are expected to grow at a constant rate of 5% per annum. The current price per share is KShs. 180. Par value per share is KShs. 50.

Required:

1. The required rate of return                                                                 
2. The percentage change in price if the required rate of return remain constant, but the estimated dividends growth rate increases to 6.5% per annum                  

iii. The implied dividend payout ratio at the end of year one, if the annual dividend growth rate remain at 5% per annum, the required rate of return remains constant but the price is KShs. 25 below the initial price.                 

Answer 1

Using Gordon Growth Model

Po = D1 / (Ke – g)

Where,

Po – Current share price = 180

D1 – Next year expected dividend = 8

Ke – Cost of equity = ?

G – Growth rate in dividend = 5%

180 = 8/(Ke-.05)

Ke-.05 = 8/180

= 0.04444444444

Ke = 0.04444444444+.05

= 0.09444444444

= 9.44%

Revised Price if growth rate changes to 6.5% = 8/(.0944-.065)

= $272.11

Percentage change in price = (272.11-180)/180 *100

= 51.17%

Growth rate = ROE*Retention ratio

Retention ratio = 5/9.44

= 52.97%

dividend payout ratio ​​​​​​​= 100-Retention ratio

= 100-52.97

= ​​​​​​​47.03%