Question

Question 18 4 Seven-Seas Co. just paid a dividend of $3 per share out of earnings of $5 per share. If its book value per share is $40.00 and its market price is $52.50 per share, calculate the required rate of return on the stock. 1 7 6

Answer 1

Provided,

Earning per share(EPS) = $5.00

Last Dividend (D0) = $3.00

Thus,

Retention ratio = 2/5 = 0.4

Book value of Share = $40.00

Market value of share(P0) = $52.50

Firstly, calculate the return on equity (ROE)

ROE = 1 EPS Book value of share

ROE =

ROE = 0.125

Now, calculate the Constant growth rate (g)

g= ROE*Retention ratio

g = 0.125*0.4

g = 0.05

Using Dividend discount model, we can calculate the required return of stock.

DO*(1 +9) PO = 1 -9

we rewrite this equation in following manner:

1. DO * (1 +9) PO +9

where,

k = required rate of return on stock.

| 3*(1+0.05) 1 +0.05 52.50

c = 0.11

k= 11%

Hope this will help, please do comment if you need any further explanation. Your feedback would be highly appreciated.