The latest dividend paid by ABC Ltd is 40 cents and the company retains 20 per cent of its earnings each year,which is invested to earn a rate of return of 25% p.a.Assuming the required rate of return on ABC's shares is 15% p.a. ,the price of ABC Ltd shares will be:
A)$3.33.
B)$5.
C)$4.
D)$4.20.

Question

Quizplus · Accepted Answer

To calculate the price of the shares using the dividend discount model, we need to use the following formula:

Price of shares = Dividend / (Required rate of return - Growth rate)

In this case, the dividend is 40 cents, and the growth rate is equal to the retention rate (20%) multiplied by the rate of return on investment (25%), which is 5%.

So, the growth rate = 0.2 x 0.25 = 0.05

Substituting the values into the formula, we get:

Price of shares = 0.40 / (0.15 - 0.05) = $4.20

Therefore, the correct answer is D, $4.20.

The Latest Dividend Paid by ABC Ltd Is 40 Cents