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4 May, 02:53

Eastern Electric currently pays a dividend of about $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?

b. If investors' required rate of return is 12%, 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 6% and the plowback ratio is. 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.)

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  1. 4 May, 06:49
    0
    a. 9.07%

    b. 5.93%

    c. 12.07%

    Explanation:

    Dividend valuation method is used to calculate the the value of stock based on the dividend paid, its growth rate and rate of return.

    Stock Price = Dividend / (Rate of return - Growth rate)

    a.

    $27 = $1.64 / (Rate of return - 3%)

    Rate of return - 0.03 = $1.64 / $27

    Rate of return - 0.03 = 0.0607

    Rate of return = 0.0607 + 0.03

    Rate of return = 0.0907 = 9.07%

    b.

    $27 = $1.64 / (12% - Growth rate)

    0.12 - Growth rate = $1.64 / $27

    0.12 - Growth rate = 0.0607

    Growth rate = 0.12 - 0.0607

    Growth rate = 0.0593 = 5.93%

    c.

    $27 = $1.64 / (Rate of return - 6%)

    Rate of return - 0.06 = $1.64 / $27

    Rate of return - 0.06 = 0.0607

    Rate of return = 0.0607 + 0.06

    Rate of return = 0.1207 = 12.07%
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