Question

You expect KT Industries (KTI) will have earnings per share of $3 this yearand expect that they will pay out $1.50 of these earnings to shareholders in the form of a dividend. KTI's return on new investments is 15% and their equity cost of capital is 12%. The value of a share of KTI's stock is closest to:
A) $39.25
B) $20.00
C) $33.35
D) $12.50

Answer 1

Answer:

C) $33.35

Explanation:

First, find the growth rate using retention rate and Return on new investment;

g= retention rate × return on new investment

Retention rate= (3.00 - 1.50) / 3.00 = 0.5

return on new investment  = 15% or 0.15 as a decimal

g= 0.5 × 0.15 = 0.075 or 7.5%

Price (P0) = Div1 / (rE- g)

= 1.50 / (0.12 - 0.075) = 33.33

Therefore, the current value of the stock is 33.33 which is closest to 33.35.