Here are data on two stocks, both of which have discount rates of 12%:
Stock A | Stock B | |||||
Return on equity | 12 | % | 10 | % | ||
Earnings per share | $ | 2.50 | $ | 1.40 | ||
Dividends per share | $ | 1.00 | $ | 1.00 | ||
a. What are the dividend payout ratios for each firm? (Enter your answers as a percent rounded to 2 decimal places.)
Stock A?
Stock B?
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.)
Stock A?
Stock B?
c. What is the proper stock price for each firm? (Do not round intermediate calculations. Round your answers to 2 decimal places.)
Stock A?
Stock B?
a . Dividend payout ratios calculation
Payout Ratio can be defined as part of earnings of the company which is paid to the shareholders in the form of dividends.
Payout Ratio = (Dividends per share / Earnings per share) * 100
For Stock A
Dividends per share = $1.00
Earnings per share = $2.50
Payout Ratio = ($1.00 / $2.50) * 100
= 40%
For Stock B
Dividends per share = $1.00
Earnings per share = $1.40
Payout Ratio = ($1.00 / $1.40) * 100
= 71.43%
b. Expected dividend growth rates calculation
Growth Rate = Retention Ratio * Return on equity
Retention Ratio = 100% - Payout Ratio
Retention Ratio for Stock A = 100% - 40%
= 60%
Retention Ratio for Stock B = 100% - 71.43%
= 28.57%
Return on equity of Stock A = 12%
Return on equity of Stock B = 10%
Therefore Growth rate
Stock A = 60% * 12%
= 7.20%
Stock B = 28.57% * 10%
= 2.86%
c. Proper stock price for each firm
Price = D1 / (Re - g)
Where D1 is Dividend for year 1
Re is the discount rate
g is the growth rate
Calculation of D1
D1 = Dividend per share * (1 + growth rate)
Stock A = $1.00 * ( 1 + 0.072)
$1.00 * 1.072
$1.072
(Note - 7.20% can also be written as 0.072)
Stock B = $1.00 * ( 1 + 0.0286)
$1.00 * 1.0286
$1.0286
(Note - 2.86% can also be written as 0.0286)
Calculation of Price
Stock A = $1.072 / (12% - 7.20%)
$1.072 / 4.80%
$22.33
Stock B = $1.0286 / (12% - 2.86%)
$1.0286 / 9.14%
$11.25
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