Question

Here are data on two stocks, both of which have discount rates of 10%: Stock A Stock B Return on equity 10 % 8 % Earnings per share $ 1.20 $ 1.50 Dividends per share $ 0.60 $ 0.60 a. What are the dividend payout ratios for each firm? (Enter your answers as a percent rounded to 2 decimal places.) b. What are the expected dividend growth rates for each stock? (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places.) c. What is the proper stock price for each firm? (Do not round intermediate calculations. Round your answers to 2 decimal places.)

Answer 1

	Stock A	Stock B
Discount Rate	10%	10%
Return on equity	10%	8%
Earning Per Share	$ 1.20	$ 1.50
Dividend Per Share	$ 0.60	$ 0.60
a.
Dividend Payout Ratio= Dividend per Share/ Earning Per Share
Dividend Payout Ratio of Stock A= $ 0.60/ $ 1.20
Dividend Payout Ratio of Stock A= 50%
Dividend Payout Ratio of Stock B= $ 0.60/ $ 1.50
Dividend Payout Ratio of Stock B= 40%
b.
Expected Dividend Growth Rate= Return on equity x ( 1 - Dividend Payout Ratio)
Expected Dividend Growth Rate of Stock A= Return on equity x ( 1 - Dividend Payout Ratio)
Expected Dividend Growth Rate of Stock A= 10% x ( 1 - 0.5)
Expected Dividend Growth Rate of Stock A= 5%
Expected Dividend Growth Rate of Stock B= Return on equity x ( 1 - Dividend Payout Ratio)
Expected Dividend Growth Rate of Stock B= 8% x ( 1 - 0.40)
Expected Dividend Growth Rate of Stock B= 4.80%
c.
Calculation of Stock Price
Price of Stock = Do( 1+g) / (ke-g)
Price of Stock A= Do( 1+g) / (ke-g)
Price of Stock A= $ 0.60( 1+0.05) / (0.10-0.05)
Price of Stock A= $ 0.63) / 0.05
Price of Stock A= $ 12.60
Price of Stock B= Do( 1+g) / (ke-g)
Price of Stock B= $ 0.60( 1+0.048) / (0.10-0.048)
Price of Stock B= $ 0.6288 / 0.052
Price of Stock B= $ 12.09