Company Q’s current return on equity (ROE) is 12%. It pays out earnings as cash

Question

Company Q’s current return on equity (ROE) is 12%. It pays out earnings as cash dividends using a payout ratio of 0.40. Current book value per share is $59. Book value per share will grow as Q reinvests earnings.

Assume that the ROE and payout ratio stay constant for the next four years. After that, competition forces ROE down to 10.5% and the payout ratio increases to 0.75. The cost of capital is 10.5%.

What are Q’s EPS and dividends in years 1, 2, 3, 4, and 5? (Do not round intermediate calculations. Round your answers to 2 decimal places.)

What is Q’s stock worth per share? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Company Q’s current return on equity (ROE) is 12%. It pays out earnings as cash dividends using a payout ratio of 0.40. Current book value per share is $59. Book value per share will grow as Q reinvests earnings.

Assume that the ROE and payout ratio stay constant for the next four years. After that, competition forces ROE down to 10.5% and the payout ratio increases to 0.75. The cost of capital is 10.5%.

Explanation / Answer

EPS

=(Net income-Dividends on preferred stock)/Number of shares

Return on equity =Net income/Shareholder’s equity

.12 =Net Income/Shareholder’s equity

Net Income =Shareholder’s equity * .12

Dividend payout ratio =Dividend/Net Income

.40 =Dividend/Net Income

Net Income =Dividend /.40

Cost of capital =(Dividend amount in next year/Current price) + dividend growth rate

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