Question

One of the most important components of stock valuation is a firm's estimated growth rate. Financial statements provide the information needed to estimate the growth rate. Consider this case: Robert Gillman, an equity research analyst at Gillman Advisors, believes in efficient markets. He has been following the mining industry for the past 10 years and needs to determine the constant growth rate that he should use while valuing Pan Asia Mining Co. Robert has the following information available: • Pan Asia Mining Co.'s stock (Ticker: PAMC) is trading at $22.50. • The company's stock is expected to pay a year-end dividend of $1.08 that is expected to grow at a certain rate. • The stock's expected rate of return is 10.80%. Based on the information just given, what will be Robert's forecast of PAMC's growth rate? 9.00% O 6.00% 10.75% 4.98% Which of the following statements accurately describes the relationship between earnings and dividends when all other factors are held constant? O Paying a higher percentage of earnings as dividends will result in a higher growth rate. O Long-run earnings growth occurs primarily because firms retain earnings and reinvest them in the business. O Dividend growth and earnings growth are unrelated.

Answer 1

This question requires application of constant growth dividend discount model according to which: Po - Divi T-9 Po = Price of Stock Divi = Estimated Dividends for Next Period r = Required Rate of Return 9= Growth Rate

Question 1:

22.50 = | 1.08 0.1080-9

0.1080 - g = 0.048

g = 6.00% ----> Answer

Question 2:

Correct statement is Statement 2

Growth Rate = ROE * (1 - Dividend payout Ratio)

This implies higher is the dividend payout ratio, lower is the growth rate. So statement 1 and 3 are clearly incorrect.