A company paid a dividend last year of $1.75.The expected ROE for next year is 14.5%.An appropriate required return on the stock is 10%.If the firm has a plowback ratio of 75%, the dividend in the coming year should be

Question

Quizplus · Accepted Answer

We can use the Gordon growth model to solve for the expected dividend in the coming year, which is:

Expected dividend = (1 - plowback ratio) x Current dividend + plowback ratio x Expected earnings x Expected payout ratio
Expected earnings = Current earnings x Expected ROE = Current dividend / Required return x Expected ROE
Expected payout ratio = 1 - plowback ratio

Plugging in the given values, we get:

Expected earnings = $1.75 / 10% x 14.5% = $2.015
Expected payout ratio = 1 - 0.75 = 0.25
Expected dividend = (1 - 0.75) x $1.75 + 0.75 x $2.015 x 0.25 = $1.94

Therefore, the answer is D.

A Company Paid a Dividend Last Year of $1