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28 December, 21:51

A stock sells for $60. The next dividend will be $3 per share. If the rate of return earned on reinvested funds is 10% and the company has a payout ratio of 40% of earnings in the firm, what must be the discount rate (r) ?

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  1. 28 December, 23:17
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    11%

    Explanation:

    MV=D1 / (Ke-g)

    Where MV=$60

    D1=$3

    Ke=?

    g=r*b

    r=10%

    b=60% as 40% profits are paid out therefore retained profits=1-.4=.6

    Now g=r*b=10%*60%=6%

    MV=D1 / (ke-g)

    60=3 / (ke-.06)

    60ke-3.6=3

    Ke = (3+3.6) / 60

    Ke=11%
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