Question

Juggernaut Satellite Corporation earned $19.6 million for the fiscal year ending yesterday. The firm also paid out 30 percent of its earnings as dividends yesterday. The firm will continue to pay out 30 percent of its earnings as annual, end-of-year dividends. The remaining 70 percent of earnings is retained by the company for use in projects. The company has 2.8 million shares of common stock outstanding. The current stock price is $84. The historical return on equity (ROE) of 14 percent is expected to continue in the future.
What is the required rate of return on the stock?

Answer 1

Answer:

The required rate of return on the stock is 12.55%

Explanation:

According to the given data we have the following:

The Company is distributing 30% of its earnings as dividends

Therefore, company is retaining = 100-30 = 70% of its earnings

Growth = Retention ratio * ROE = 0.7*0.14 = 9.8%

Earning = 19.6 million

hence, Paid as dividends = 19.6*0.3 = $5.88 million

The Number of shares outstanding = 2.8 million

hence, Dividend per share = Total dividends / number of shares outstanding = 5.88/2.8 = $2.1

Current stock price = $84

Therefore, to calculate the required rate of return on the stock we would have to use the following formula:

Price of stock = Current dividend*(1+growth)/(r-growth), where r is required rate of return

84 = 2.1*(1.098)/(r-0.098)

40 = 1.098/(r-0.098)

r - 0.098 = 0.02745

r = 0.02745+0.098 = 0.12545

The required rate of return on the stock is 12.55%