The company just paid its annual dividend of $4.75. You believe the dividend wil
ID: 2653130 • Letter: T
Question
The company just paid its annual dividend of $4.75. You believe the dividend will grow constantly at 9.1% per year. Today’s P/E ratio is 9.1 and the payout ratio is 70%. You assess the stocks intrinsic value with a 17.0% discount rate. Find the one-year rate of return from buying today @ the market price and holding it one year, receiving next year’s dividend and selling, given that next year’s share price converges to its price according to the dividend growth model. Hint: P0 is based on P/E and P1 is based on dividend growth model
Select one:
a. 20.31%
b. 25.98%
c. 24.29%
d. 18.49%
e. 16.57%
Explanation / Answer
P/E = 9.1
Annual dividend = 4.75 and payout ratio = 70%. Thus 70% of earnings are paid out as dividends.
70% of earnings = 4.75, or earnings = 4.75/0.7 = $6.79 per share
P/6.79 = 9.1
or P0 = 6.79*9.1 = $61.75
Thus today's market price = 61.75
Dividend received next year = 4.75*(1.091) = $5.18. This is D1. r= 17%
Using the formula: P0 = D1/(1+r)+P1/(1+r)
61.75 = 5.18/(1.17)+P1/(1.17)
61.75 = 4.43+P1/(1.17)
P1/(1.17) = 57.32
P1 = 67.06
Thus return = [D1+(P1-P0)]/P0
= [5.18+(67.06-61.75)]/61.75
= 10.49/61.75 = 0.1657 OR 16.57%
Answer is option "E"