Question

In: Finance

A stock sells for $40. The next dividend will be $4 per share. If the rate...

A stock sells for $40. The next dividend will be $4 per share. If the rate of return earned on reinvested funds is 15% and the company reinvests 60% of earnings in the firm, what is the expected rate of return on the stock?

Expert Solution

Solution:

Calculation of growth rate:

As per the information given in the question we have

Rate of return earned on reinvested funds is = 15 % i.e., ROE = 15 %

The company reinvests 60 % of earnings in the firm, thus the Retention ratio is = 60 % = 0.6

The formula for calculating the growth rate is = ROE * Retention Ratio

Applying the available information we have growth rate as

= 15 % * 0.6 = 9 %

Thus the growth rate = 9 %

Calculation of the expected rate of return on the stock :

The price of a stock can be calculated using the following formula :

P0 = D1 / ( Ke – g )

Where,

P0= Price of the stock

D1 = Next dividend payment

Ke = Expected rate of Return

g = growth rate

As per the information given in the question we have

P0 = $ 40 ; D1 = $ 4 ; g = 9 % = 0.09 ; Ke = to find

Applying the above values in the formula we have

40 = 4 / (Ke – 0.09 )

40 * (Ke – 0.09 ) = 4

(Ke – 0.09 ) = 4 / 40

(Ke – 0.09 ) = 0.10

Ke = 0.09 + 0.10 = 0.19

Thus Ke = 19 %

Thus the Expected rate of return of the stock is = 19 %

jeff jeffy answered 2 years ago

A stock is selling for $40 per share currently. The next dividend will be $1 per share, and will grow at 12% per year forever.

A stock is selling for $40 per share currently. The next dividend will be $1 per share, and will grow at 12% per year forever. What is the rate of return required by investors? Answer: 14.5%

The stock of Business Adventure currently sells for $40 per share. Its dividend payment and its...

The stock of Business Adventure currently sells for $40 per share. Its dividend payment and its year-end price depend on the state of the economy as follows: Dividend Stock Price Boom $2.00 $50 Normal Economy 1.00 43 Recession 0.50 34 Assume the three states of the economy is equally likely to happen. Expected Return of the stock this year is: 8.75% Standard Deviation of the stock return for this year is: 17.91% Risk premium of business adventures stock is 4.75%...

A stock expects to pay a dividend of $3.72 per share next year. The dividend is...

A stock expects to pay a dividend of $3.72 per share next year. The dividend is expected to grow at 25 percent per year for three years followed by a constant dividend growth rate of 4 percent per year in perpetuity. What is the expected stock price per share 5 years from today, if the required return is 12 percent?

Find the price for a stock given that the next dividend is $2.38 per share, the...

Find the price for a stock given that the next dividend is $2.38 per share, the required return is 9.6%, and the growth rate in dividends is 1.3% per year.

Holtzman Clothiers's stock currently sells for $40 a share. Itjust paid a dividend of $3.5...

Holtzman Clothiers's stock currently sells for $40 a share. It just paid a dividend of $3.5 a share (i.e., D0 = $3.5). The dividend is expected to grow at a constant rate of 4% a year.a. What stock price is expected 1 year from now?b. What is the required rate of return?

Holtzman Clothiers's stock currently sells for $40 a share. It just paid a dividend of $3.5...

Holtzman Clothiers's stock currently sells for $40 a share. It just paid a dividend of $3.5 a share (i.e., D0 = $3.5). The dividend is expected to grow at a constant rate of 4% a year. a. What stock price is expected 1 year from now? b. What is the required rate of return?

1.) XYZ Corporation's next dividend is expected to be $3 per share. Dividend growth rate has...

1.) XYZ Corporation's next dividend is expected to be $3 per share. Dividend growth rate has been at 2% and expected to be so into the future. If investor's return is 10%, calculate the stock price next year. A) 37.50 B) 38.25 C) 38.50 D) 38.75 E) None of the above Which of the following typically applies to preferred stock but not to common stock? A) Par Value B) Dividend yield C) Cumulative dividends D) It is legally considered equity...

ABC's common stock is currently selling for $40 per share. The dividend expected to be paid...

ABC's common stock is currently selling for $40 per share. The dividend expected to be paid at the end of the coming year is $5. Its dividend payments have been growing at a constant rate for the last 5 years. 5 years ago, the dividend was $3.2. It is expected that to sell, a new common stock issue must be underpriced by $1 per share in floatation costs and a new common stock must be underderpriced $1 per share. show...

An investor buys a stock for $40 per share and simultaneously sells a call option on...

An investor buys a stock for $40 per share and simultaneously sells a call option on the stock with an exercise price of $42 for a premium of $3 per share. Ignoring the dividends and transaction costs, what is the maximum profit the writer of this covered call can earn if the position is held to expiration?

A stock is expected to pay a dividend of $2.74 per share next year, $3.2 two...

A stock is expected to pay a dividend of $2.74 per share next year, $3.2 two years from now, and $3.38 three years from now. After that, the dividend is expected to grow at a constant rate of 5% per year indefinitely. The required return on the stock is 9%. The estimated price per share is $___________. Rounding and Formatting: Do not enter a dollar sign in your response. Round your answer to 2 decimal places. Example: If your answer...