Eastem Electric currently pays a dividend of about $1.78 per share and sells for

Question

Eastem Electric currently pays a dividend of about $1.78 per share and sells for $36 a share a. If investors believe the growth rate of dividends is 3% per year, what is the opportunity cost of capital? (Do not round intermediate calculations. Round your answer to 2 decimal places.) Cost of Capital b. If investors' opportunity cost of capital is 12%, what must be the growth rate they expect of the firm? (Do not round intermediate calculations. Round your answer to 2 decimal places.) Growth rate C. If the sustainable growth rate is 5% and the plowback ratio is .4, what must be the return on equity ROE? (Round your answer to 2 decimal places.) ROE

Explanation / Answer

price = dividend next year /(required rate of return - growth rate)

a)

36 = 1.78*1.03/r-3%

=>

cost of capital r = 8.09%

b)

36 = 1.78*(1+g)/12%-g

=>

4.32 -36g = 1.78 + 1.78g

=>

growth rate g = 6.72%

c)

sustainable growth rate = ROE * (1-plowback ratio)

ROE = 5%/(1-0.4)

= 8.33%

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