Lory Company had net earnings of $127,000 this past year of which $46,200 was paid out in dividends.The company's equity was $1,587,500.Lory has 200,000 shares outstanding with a current market price of $11.63 per share.Both the number of shares and the dividend payout ratio are constant.What is the required rate of return if the growth rate is 5.6 percent?
A)8.42 percent
B)6.67 percent
C)7.70 percent
D)7.39 percent
E)8.24 percent

Question

Quizplus · Accepted Answer

We can use the dividend discount model to solve for the required rate of return:

D1 = D0(1+g)
D1 = 46,200(1+0.056)
D1 = 48,732

P0 = D1 / (r - g)
11.63 = 48,732 / (r - 0.056)
11.63r - 0.651 = 48,732
11.63r = 48,732 + 0.651
11.63r = 48,732.651
r = 48,732.651 / 11.63
r = 4,182.98 / 1,000
r = 0.0770 or 7.70%

Therefore, the required rate of return is 7.70% (choice C).

Lory Company Had Net Earnings of $127,000 This Past Year