Computer stocks currently provide an expected rate of return of 24%. MBI, a larg

Question

Computer stocks currently provide an expected rate of return of 24%. MBI, a large computer company, will pay a year-end dividend of $3.60 per share. If the stock is selling at $66 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. Omit the "%" sign in your response.) If dividend growth forecasts for MBI are revised downward to 11 % per year, what will happen to the price of MBI stock? What (qualitatively) will happen to the company's price-earnings ratio?

Explanation / Answer

A) Constant dividend model formula is Share price = dividend /(expected return - growth rate)

or P = D1 / (Ke - g)

substituting , we get as below 66 = 3.6/(0.24-g)

On solving we get g = 18.55%

B-1) If dividend forecast goes down, retained earnings will raise, as a result price of the stock will increase

B-2) Formula for price earnings ratio is market price per share/ earnings per share,since market price increases, the price will increase

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