Question

a. Computer stocks currently provide an expected rate of return of 14%. MBI, a large computer company, will pay a year-end dividend of $3 per share. If the stock is selling at $60 per share, what must be the market's expectation of the growth rate of MBI dividends? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

b. If dividend growth forecasts for MBI are revised downward to 4% per year, what will be the price of the MBI stock? (Round your answer to 2 decimal places.)

c. What (qualitatively) will happen to the company's price–earnings ratio?

• The P/E ratio will decrease.

• The P/E ratio will increase.

Answer 1

a). Calculating the Expected growth rate of MBI dividends:-

where, Ke = expected rate of return = 14%

D1= Expected dividend at year end = $3

P0 = Current Price = $ 60

g = 0.14 - 0.05

g = 9%

So, the Expected growth rate of MBI dividends is 9%

b). Now, the growth rate are revised downward to 4% per year and all other information remains the same.

where, Ke = expected rate of return = 14%

D1= Expected dividend at year end = $3

g = growth rate = 4%

So, price of the MBI stock is $ 30

c). Since after the growth rate revised to downward, the price of Stock aslo declined from $ 60 to $ 30

P/E Ratio = Market price per share/Earning per share

As EPS remains the same after growth rate declined, but Market price has declined. Thus, decrease in price will ecrease the P/E ratio.

hence, The P/E ratio will decrease.

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