Exercise 4-2 Please use the following information for questions 1-10 (be careful

Question

Exercise 4-2 Please use the following information for questions 1-10 (be careful about rounding). Stock A pays a dividend of $3 per share in year zero. In year 1, the dividend is $3.3 per share," The dividend growth rate is constant and the return on equity is 25%. 1. What is earnings per share in year 0 ? A) S6 B) $5 C) $4 D) $3 E) None of the above 2. What is earnings per share in year 1 A) $6.0 B) $5.5 C) $4. D) $5.0 E) None of the above 3. What is earnings per share in year 2? A) $6.05 B) $5.65 C) $4.75 D) $3.85 E) None of the above 4. What is the dividend per share in year 2? A) $3.55 B) $3.63 C) $3.30 D) S3.75 E) None of the above 5. What is the payout ratio at year 1 ? A) 0.5 B) 0.4 C) 0.6 D) 0.3 E) None of the above 6. What is the payout ratio at year 3 ? A) 0.5 B) 0.4 C) 0.6

Explanation / Answer

D0 3 D1 3.3 ROE 25% growth rate is constant g = (3.3-3)/3 = 10% Plowback ratio = Growth rate / ROE 10%/25% = 0.4 Payout ratio = 1-0.4 = 0.6 1 B $5 Explanation D0/payout ratio 3/0.6 = 5 2 B $5.5 Explanation $5 x 1.1 = 5.5 3 A $6.05 Explanation $5.5 x 1.1 = 6.05 4 B $3.63 Explanation $3.3 x 1.1 = $3.63 5 C 0.6 Explanation Payout will be constant 6 C 0.6 Explanation Payout will be constant 7 B 0.4 Explanation plow back ratio will be constant 8 B 0.4 Explanation plow back ratio will be constant 9 D $22 Explanation P0 = D1/Ke-g 3.3/25%-10% $22 10 B $32 Explanation $22 x 1.1^4 = 32 rounded

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