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.) Growth rate If dividend growth forecasts for MBI are revised downward to 11% per year, what will happen to the price of MBI stock? The price will fall. The price will rise. What (qualitatively) will happen to the company's price-earnings ratio? The price-earnings ratio will fall. The price-earnings ratio will rise.

Explanation / Answer

Answer (a)

Growth rate   = 18.55 %

Answer (b-1)

If the dividend forecast for MBI is revised downwards to 11% per year,   the Price will fall

Answer (b-2)

What will happen in b to price earnings ratio -   the price earnings ratio will fall

Expected rate of return = 24%

Current Price = $66

Expected year-end dividend = $ 3.60

Price of the stock   = Expected Dividend / (Expected return – growth rate of Dividend)

$ 66 = $ 3.60 / (0.24 – growth rate of dividend)

0.24 – growth rate of dividend = $ 3.60/$ 66

Growth rate of dividend = 0.24 – ($3.60/$66)

Growth rate of dividend = 0.24 – 0.054545

Growth rate of dividend = 0.18545 or 18.55% (rounded off)

If the dividend growth factor is revised downwards to 11% then

Price of stock = $3.60/(0.24 – 0.11) = $ 27.69

The growth rate of dividends and earnings determines the rate at which the earnings grow. If the growth rate is revised downwards, the earnings per share will fall.

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