Question

Eastern Electric currently pays a dividend of $1.64 per share and sells for $27 a share. a. If investors believe the growth rate of dividends is 3% 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.) b. If investors' required rate of return is 10%, 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.) c. If the sustainable growth rate is 5% and the plowback ratio is 0.4, 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.)

Answer 1

Answer:

rate of return is 9.26%

growth rate is 3.70%

expected rate of return is 12.50%

Explanation:

stock price=Do*(1+g)/(r-g)

Do is the dividend per share of $1.64

g is the dividend growth rate of 3%

r is the rate of return that is unknown

stock price is $27

27=1.64*(1+3%)/(r-3%)

27=1.64*(1+0.03)/(r-0.03)

27=1.6892 /(r-0.03)

r-0.03=1.6892 /27

r=(1.6892/27 )+0.03

r=9.26%

If r=10.00%

g=?

27=1.64*(1+g)/(10%-g)

27(10%-g)=1.64*(1+g)

2.7-27g=1.64+1.64g

2.7-1.64=1.64g+27g

1.06=28.64g

g=1.06/28.64

g=3.70%

Growth rate=cost

C.

expected rate of return =sustainable growth rate /plowback ratio

sustainable growth rate is 5%

plowback ratio is 0.4

expected rate of return =5%/0.4=12.50%