Suppose that the consensus forecast of security analysts of your favorite compan

Question

Suppose that the consensus forecast of security analysts of your favorite company is that earnings next year will be E1 = $5:00 per share. Suppose that the company tends to plow back 50% of its earnings and pay the rest as dividends. If the Chief Financial Officer (CFO) estimates that the company's growth rate will be 8% from now onwards, answer the following questions.

Suppose your own 10% estimate of the stock's required rate of return is shared by the rest of the market. What does the market price of $50.00 per share imply about the market's estimate of the company's growth rate?

Explanation / Answer

According to DIvidend discount model

Price of share = D1/(r-g)

where r is required rate of return i.e 10%

g is growth rate

D1 is nxt year dividend

so, according to market sentiments and based on dividend discount model

50 = 2.5/(.1-g)

g = .1-(2.5/50) = 0.05 = 5%

growth rate estimated by market = 5%

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