The dividends and earnings of AG stores plc over the last five years have been a

Question

The dividends and earnings of AG stores plc over the last five years have been as follows.

Year    Dividends ($) Earnings ($)

2013    150,000           400,000

2014    192,000           510,000

2015    206,000           550,000

2016    245,000           650,000

2017    262,350           700,000

The company is financed entirely by equity and there are 1,000,000 shares in issue, each with a market value of $3.35 ex div.

a). what is the dividend growth rate over the last four years? Use the formula-Do(1+g)^n

b). what is the cost of equity?

c). what implications does the dividend growth appear to have for earnings retentions?

Explanation / Answer

(a) Dividend at end of 2013 = $ 150000 OR $ 0.15 per share and Dividend at end of 2017 = $ 262350 OR $ 0.262350 per share

Let dividend growth rate be g

Therefore, 150000 x (1+g) ^(4) = 262350. Solving this equation we get g = 0.1499 OR 14.99%

(b) In 2017:

Net Income = $ 700000. Number of shares outstanding = 1million.

Earnings Per Share (EPS) = 700000 / 1000000 = $ 0.7

Dividends Per Share (DPS) = 262350 / 1000000 = $ 0.262350

Therefore, Payout Ratio = DPS / EPS = 0.375 and Retention Ratio = 1 - Payout Ratio = 0.625

ROE = Net Income / (Current Stock Price x Number of Outstanding Shares) = 700000 / (3.35 x 1000000) = 700000 / 3350000 = 0.208

Therefore, expected dividend growth rate for 2018 = ROE x Retention Ratio = 0.208 x 0.625 = 0.1306 OR 13.06 %

Therefore, Expected Dividend in 2018 = 262350 x 1.1306 = $ 296623.87 OR $ 0.2966 per share

Let the cost of equity be r

Therefore, by the market capitalization equation:

r = (Dividend Expect in 2018 / Current Market Price) + g = (0.2966 / 3.35) + 0.1306 = 0.219 OR 21.9 %

(c) The dividend growth has not majory impacted the earnings retention in terms of proportion. This essentially means the amount of earnings retained and the amount paid out as dividend have remained almost constant in terms of proportion. This also means that as earnings have grown and the relative proportion of dividends & retention have remained constant, both dividend and retained earnings have grown in absolute terms.

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