Question

a. Computer stocks currently provide an expected rate of return of 16%. MBI, a large computer company, will pay a year-end dividend of $2 per share. If the stock is selling at $50 per share, what must be the market's expectation of the growth rate of MBI dividends? (Do not round intermediate calculations. Round your answer to 2 decimal places.) b. If dividend growth forecasts for MBI are revised downward to 5% per year, what will be the price of the MBI stock? (Round your answer to 2 decimal places.) c. What (qualitatively) will happen to the company's price–earnings ratio? The P/E ratio will decrease. The P/E ratio will increase.

Answer 1

Answer:

a)

$50 = $2 / (16% - g)

16% - g = $2 / $50 = 4%

g = 16% - 4% = 12%

expected growth rate = 12%

b)

P₀ = $2 / (16% - 5%)

P₀ = $2 / 11%

P₀ = $18.18

c)

P/E ratio = share price / EPS

since the share price decreases from $50 to $18.18, the P/E ratio will decrease. When you are dividing a number, if the numerator decreases while the denominator remains still, the answer will decrease.