Please Help!!! Constant-Growth Model. A stock sells for $40.The next dividend wi

Question

Please Help!!! Constant-Growth Model. A stock sells for $40.The next dividend will be $4 per share. If the rate of returnearned on reinvested funds is 15 percent and the company reinvests40 percent of earnings in the firm, what must be the discountrate? Please Help!!! Constant-Growth Model. A stock sells for $40.The next dividend will be $4 per share. If the rate of returnearned on reinvested funds is 15 percent and the company reinvests40 percent of earnings in the firm, what must be the discountrate?

Explanation / Answer

Stock Price (P0) = $40 Next Dividend (D1) = $4 pershare Rate of return earned on reinvestedfunds = 15% Earnings Retention Ratio = 40% Dividend growth rate = Rate ofreturn on retained earnings * Earnings RetentionRatio Dividend growth rate = 15% * 40% Dividend growth rate (g) = 0.15 *0.40 Dividend growth rate (g) = 0.06(or) 6% P0 = D1 /(R-g) $40 = $4 / (R - 0.06) R = [ $4 / $40 ] + 0.06 Discount rate ( R) = 0.16(or) 16% Stock Price (P0) = $40 Next Dividend (D1) = $4 pershare Rate of return earned on reinvestedfunds = 15% Earnings Retention Ratio = 40% Dividend growth rate = Rate ofreturn on retained earnings * Earnings RetentionRatio Dividend growth rate = 15% * 40% Dividend growth rate (g) = 0.15 *0.40 Dividend growth rate (g) = 0.06(or) 6% P0 = D1 /(R-g) $40 = $4 / (R - 0.06) R = [ $4 / $40 ] + 0.06 Discount rate ( R) = 0.16(or) 16%

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