Acoustic Industries has a dividend yield of 4.5% and a cost of equity capital of

Question

Acoustic Industries has a dividend yield of 4.5% and a cost of equity capital of 12%.Acoustic Industries' dividends are expected to grow at a constant rate indefinitely, The growth rate of Acoustic's dividends is7.5% 5.5% 16.5% 12% None of the above JRN Enterprises just announced that it plans to cut its dividend from S2.50 to $1.50 per share and use the extra funds to expand its operations. Prior to this announcement, JRN's dividends were expected to grow at 4% per year and JRN's stock was trading at $25.00 per share. With the new expansion, JRN's dividends are expected to grow at 8% per year indefinitely. Assuming that JRN's risk is unchanged by the expansion, the value of a share of JRN after the announcement is closest to: $15.00 $31.25 $27.50 None of the above

Explanation / Answer

26

Calculation of Growth Rate:

Given that :

Dividend Yield = 4.5%

Formula :

Dividend Yield = Dividend Per share / Market Price of Share

Assuming Market Price is $100

Hence Dividend Per share = 100*4.5% = $4.5

Given that :

Cost of Equity = 12%

Formula :

Cost of Equity = Earnings Per share / Market Price of Share

Assuming Market Price is $100

Hence Earnings per share = $100 * 12% = $12

Formula :

Dividend Growth rate = Cost of Equity / Retention Ratio

Cost of Equity = 12%

Retention Ratio = (1 - (Dividend Per Share / Earnings Per share ))

Retention Ratio = (1 - (4.5 / 12 ))

Retention Ratio = 0.625

Dividend Growth rate = 12% / 0.625 = 19.2%

26

Calculation of Growth Rate:

Given that :

Dividend Yield = 4.5%

Formula :

Dividend Yield = Dividend Per share / Market Price of Share

Assuming Market Price is $100

Hence Dividend Per share = 100*4.5% = $4.5

Given that :

Cost of Equity = 12%

Formula :

Cost of Equity = Earnings Per share / Market Price of Share

Assuming Market Price is $100

Hence Earnings per share = $100 * 12% = $12

Formula :

Dividend Growth rate = Cost of Equity / Retention Ratio

Cost of Equity = 12%

Retention Ratio = (1 - (Dividend Per Share / Earnings Per share ))

Retention Ratio = (1 - (4.5 / 12 ))

Retention Ratio = 0.625

Dividend Growth rate = 12% / 0.625 = 19.2%

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