A Cement Company has had the following pattern of earnings per over the last fiv

ID: 3124084 • Letter: A

Question

A Cement Company has had the following pattern of earnings per over the last five years: The earnings per share have grown at a constant rate (on a rounded basis) and will continue to do so in the future. Dividends represent 40 percent of earnings. Project earnings and dividends for the year (20X6). If the required rate return (K_t) 13 percent, what is the anticipated stock price (P_0) at the beginning of 20X6? A firm pays a $1.50 dividend at the end of year one (D_1), has a stock price of $155 (P_0), growth rate (g) 10 percent. a. Compute the required rate of return (K_t) Indicate whether each of the following changes would make the required rate of return (K_t) go up or down. (Each question is separate from the others. That is, assume only one variable changes at a time.) No actual numbers are necessary. b. The dividend payment increases. c. The expected growth rate increases. d The stock price increases.

Explanation / Answer

Solution

First to find the annual growth rate of earning per share,

Growth rate percent = 100 x {(current year’s earnings/preceding year’s earnings) – 1}

The growth rates are given below:

Earning/share

Growth rate

5.3

5.62

6.037735849

5.96

6.049822064

6.32

6.040268456

So, there is a constant 6% growth and hence projected earning for 20X6

= (Earning for 20X5) x 1.06 = $6.70 ANSWER 1

Given, dividends forms 40% of earnings,

projected dividend for 20X6 = 6.70 x 0.4 = $0.27 ANSWER 2

If the required rate of return is 13%, then 6.70 should be 13% of the stock price. So, the anticipated stock price

= 6.70/0.13 = $51.53 ANSWER 3