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1) Consider a stock that will have price of $35
1) Consider a stock that will have price of $35.04 one year from now and pay a dividend of $4.35 in one year. The expected rate of return is 5.7%. What is the current price of the stock?
2.A stock has a return on equity of 15.7% and a plowback ratio of 50%. What is the sustainable growth rate? Enter you answer as a percentage. Do not include the percentage sign in your answer.
3.Consider a stock that will have dividends in the next three periods of $1.34, $1.61, and $1.67, respectively. The interest rate is 12%. What is the growth rate of the dividend in period 3? Enter your answer as a percentage. Do not include the percentage sign in your answer.
4.Stark Industries expects an earnings per share of $2.8 and reinvests 45% of its earnings. Management projects a rate of return of 2% on new projects and investors expect a 9% rate of return on the stock. What is the sustainable growth rate? Enter your answer as a percentage. Do not include the percentage sign in your answer.
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Expert Solution
1) Computation of Current Price of Stock:
Current Price of the Stock =(Price one year from now + Dividend in one year)/(1+r)
=(35.04+4.35)/(1+5.7%)
=37.27
2) Computation of Sustainable Growth Rate:
Sustainable Growth Rate = Return on Equity * Plow back Ratio
= 15.7% * 50%
= 7.85%
3) Computation of Growth Rate of the Dividend in Period 3:
Growth rate of the dividend in period 3 = (Dividend in year 3 - Dividend in year 2) / Dividend in year 2
= ( 1.67 - 1.61) / 1.61
= 0.06 / 1.61
= 3.73%
Growth rate of the dividend in period 3 = 3.73%
4) Computation of Sustainable Growth Rate:
Sustainable growth rate (g)=Retention ratio*Return on equity
Here,
Retention ratio=45%
Return on equity=2%
Sustainable Growth Rate = 45%*2%=0.9%
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