Question

Eastern Electric currently pays a dividend of about $1.95 per share and sells for $32 a share.

a.	If investors believe the growth rate of dividends is 4% per year, what rate of return do they expect to earn on the stock? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

Rate of return

%

b.	If investors' required rate of return is 12%, what must be the growth rate they expect of the firm? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

Growth rate

%

c.	If the sustainable growth rate is 4% and the plowback ratio is .2, what must be the rate of return earned by the firm on its new investments? (Enter your answer as a percent rounded to 2 decimal places.)

Rate of return

%

Answer 1

A)The calculation of rate of return is shown below:

Rate of return = Dividend * (1+growth rate)/p + growth rate

= $1.95 * (1+4%)/$32 + 4%

= $2.028/$32 + 0.04

= 10.34%

B)The calculation of growth rate is shown below:

Rate of return = Dividend * (1+growth rate)/p + growth rate

0.12 = $1.95 * (1+ growth rate)/$32 + Growth rate

(0.12 - Growth rate) * $32 = $1.95 + 1.95 Growth rate

$3.84 - 32 growth rate = $1.95 + 1.95 Growth rate

$1.89 = 33.95 Growth rate

Growth rate = $1.89/33.95 = 5.57%

C)The calculation of rate of return is shown below:

Rate of return = Sustainable growth rate/rate of return

= 4%/0.2

= 20%