Homework Answers
ROE = 20%
B0 = $18 (Book value per stock share)
Hence, return or Earnings per share = 0.20 x 18 = $3.6 per stock share
Payout ratio = 30%
Dividend payout = 0.30 x $ 3.6 = $1.08 per stock share which is the annual residual income.
From the end of year 6 to infinity, the continuing residual income is a perpetuity.
So this annual residual income would continue to infinity.
PV of a perpetuity = Pmt / r = $1.08 / 0.12 (where the required rate of return to stockholders is used to discount the perpetuity)
=$9
Hence the present value of the stock share or the value of the stock share as per the residual income model = $18 + $9 = $27
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