Eastern Electric currently pays a dividend of about $1.81 per share and sells fo

Question

Eastern Electric currently pays a dividend of about $1.81 per share and sells for $30 a share.

If investors believe the growth rate of dividends is 3% per year, what is the opportunity cost of capital?(Do not round intermediate calculations. Round your answer to 2 decimal places.)

If investors' opportunity cost of capital is 15%, what must be the growth rate they expect of the firm?(Do not round intermediate calculations. Round your answer to 2 decimal places.)

If the sustainable growth rate is 5% and the plowback ratio is .5, what must be the return on equity ROE? (Round your answer to 2 decimal places.)

Eastern Electric currently pays a dividend of about $1.81 per share and sells for $30 a share.

Explanation / Answer

Hi,

Please find the answer as follows:

Part A:

Opportunity cost of capital = D1/Current Stock Price + g

D1 = 1.81*(1+.03) = 1.8643

Opportunity cost of capital = 1.8643/30 + .03 = 9.21%

Part B:

30 = 1.81*(1+g)/(.15 - g)

4.5 - 30g = 1.81 + 1.81g

31.81g = 2.69

Growth Rate = 2.69/31.81 = 8.46%

Part C:

Return on Equity = Sustainable Growth Rate/Plowback Ratio = 5%/.5 = 10%

Thanks.

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