Question

a. Show the formula you use to solve the problems, and the corresponding numbers in the formula. Show all the steps.

b. Show all the inputs and outputs.

JetHair’searnings are $6 per share. The firm’s ROE is 50%and its plowback ratio is 40%.

a. What is JetHair’sdividend for next year ?

b. What is the current stock price if its required rate of return is 35%?

Answer 1

(a)- JetHair’s Dividend for next year

Step-1, The Calculation of the Dividend Growth Rate (g)

Dividend Growth Rate (g) = Return on Equity x Plowback Ratio

= ROE x Plowback Ratio

= 50% x 0.40

= 20%

Step-2, Calculation of the Current Year Dividend per share (D0)

Current Year Dividend per share (D0) = Earnings per share x (1 – Plowback Ratio)

= $6.00 per share x (1 – 0.40)

= $6.00 per share x 0.60

= $3.60 per share

Step-3, Calculation of the Dividend for the Next Year (D1)

Dividend for the Next Year (D1) = Current Year Dividend x (1 + Growth Rate)

= D0 x (1 + g)

= $3.60 per share x (1 + 0.20)

= $3.60 x 1.20

= $4.32 per share

“JetHair’s Dividend for next year (D1) = $4.32 per share”

(b)-Current stock price if its required rate of return is 35%

Dividend for the next year (D1) = $4.32 per share

Dividend Growth Rate (g) = 20%

Required Rate of Return (Ke) = 35%

As per Constant Growth Rate Dividend Valuation Model, The Current stock price

= D1 / (Ke - g)

= $4.32 / (0.35 – 0.20)

= $4.32 / 0.15

= $28.80 per share

“Hence, the Current stock price would be $28.80 per share”