Question

Problem 2 (12p) The Shamrock Dogfood Company (SDC) has consistently paid out 40% of its earnings in dividends. (a) The company's return on equity is 16%.What would you estimate as its dividend growth rate? (b) Given the low risk in dog food, your required return on SDC is 13%.What P/E ratio would you apply to the firm's earnings? (c) What P/E ratio would you apply if you learned that SDC had decided to increase its payout to 50%? (Hint: This change in payout has multiple effects.)

Answer 1

Solutions a) Dividend pay Dividend Payout Ratio - hoy = 0.4 So, Retention Ratio = 1- Dividend Payout Ratis =1-04 20.6 Return on Equity tR06)= 16%. Og 0.16 Dividend Growth Rate > ROEx Retention Ratio 0.16 X 0.6 = 0.096 or 9.6 % (6) Now, we need to collect PIE Ratio if required Date of retum is 184. 1. Required Rate of Return = 13% or 0.13 PLE Ratio , Dividend Payout Ratio in Dividend Growth Rate 0.40 0.13-0.096 0.40 0.034 2 11.76

I calculate PIE Ratio if Dividend Payout Ratio is soy. So, if Dividend Payout Ratio = 504 or 0.5 1. So, Retention Ratio - 1-0.5 =0.5 Dividend Required PIE Growth Rate = ROEX Retention Ratio - 0.16X0.5 - 0.08 Rate of Return = 0.13 Ratio - Dividend Payout Ratio Required Rate of Retron- Dividend Gruth Rate - 05 0.13-0.08 so z 0.5 = 10 10 : 0.05

So, p/e ratio of 11.76 will be applied in part (b) to the earnings and p/e ratio of 10 will be applied to earnings in part (c).