Difference Makers earned $9.8 million for the fiscal year ending yesterday. The

Question

Difference Makers earned $9.8 million for the fiscal year ending yesterday. The firm also paid out 35 percent of its earnings as dividends yesterday. The firm will continue to pay out 35 percent of its earnings as annual, end-of-year dividends. The remaining 65 percent of earnings is retained by the company for use in projects. The company has 2.8 million shares of common stock outstanding. The current stock price is $48. The historical return on equity (ROE) of 14 percent is expected to continue in the future. What is the required rate of return on the stock? (Hint: use the retention ratio and ROE to estimate the growth rate)

9.64%
13.29%
10.32%
12.57%
11.88%

Explanation / Answer

growth rate = 14% * 0.65 = 9.10%

dividend next year = 9.8*0.35* 1.091/2.80 = 1.3365

the required rate of return on the stock = 1.3365/48 + 9.10% = 11.88%

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