Computer stocks currently provide an expected rate of return of 16%. MBI, a larg

Question

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.)

1. 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.)

2. What (qualitatively) will happen to the company's price–earnings ratio?

Explanation / Answer

From Gordon model we get following

Price = D / (K-g)

Here D is next year dividend, K is required rate of return, g is growth rate

50 = 2 / (16%-g)

So we get g as 12.00%

1. If g is changed to 5%

Price = 2 / (16% - 5%) = $18.18

2. If dividend growth rate is forecasted to be reduced, this will have a negative impact on stock price, so price of the stock will go down. Which in turn reduces Price to Earnings ratio.

Related Questions

Navigate

• Browse (All)
• Browse C
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.