Seven-Seas Co.just paid a dividend of $3 per share out of earnings of $5 per share.If its book value per share is $40 and its market price is $52.50 per share,calculate the required rate of return on the stock.
A)12%
B)11%
C)5%
D)6%

Question

Quizplus · Accepted Answer

The dividend payout ratio is 3/5 or 60%. 
The dividend yield is 3/52.5 or 5.71%. 
The earnings yield is 5/52.5 or 9.52%. 
The return on equity is (earnings per share/book value per share) or 12.5%. 
The required rate of return is the sum of the dividend yield and the growth rate of earnings (which can be assumed to be the return on equity, since the company is not retaining any earnings). Therefore, the required rate of return is approximately 11%.