Question

Here are data on two stocks, both of which have discount rates of 15%: Return on equity Earnings per share Dividends per share Stock A 15% $2.50 $1.00 Stock B 10% $1.90 $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 40.00% Stock B 52.63 % Dividend payout ratios 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 Expected dividend growth rates 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 Stock price

Answer 1

a)
Calculation of dividend payout ratio:

Dividend payout ratio = Dividend per share / Earnings per share

Stock A = $1/$2.50 = 0.40 Or 40%
Stock B = $1/$1.90 = 0.5263 Or 52.63%

b)
Dividend Growth Rate = (Retention Ratio)*(Return on Equity)
Retention ratio = 1 - payout ratio
Retention ratio for stock A = 1 - 0.40 = 0.60 or 60%
Retention ratio for stock B = 1 - 0.5263 = 0.4737 or 47.37%

Dividend growth rate for stock A = 0.60 * 0.15 = 0.09 or 9%
Dividend growth rate for stock B = 0.4737 * 0.10 = 0.04737 or 4.737%

c)
Stock price = Dividend for the next year / (Discount rate - Growth rate)

Stock price for stock A = $1 * (1+0.09) / (0.15 - 0.09)
= 1.09/0.06
= $18.17

Stock price for stock B = $1 * (1+0.04737) / (0.15 - 0.04737)
= 1.04737/0.10263
= $10.21