You expect KT industries (KTI)will have earnings per share of $5 this year and expect that they will pay out $1.25 of these earnings to shareholders in the form of a dividend. KTI's return on new investments is 13% and their equity cost of capital is 15%. The expected growth rate for KTI's dividends is closest to ________.

Question

Quizplus · Accepted Answer

Using the dividend growth model:

Expected dividend payout = EPS x payout ratio = $5 x 0.25 = $1.25

Expected growth rate = Retention rate x return on new investments = (1 - payout ratio) x return on new investments = 0.75 x 13% = 9.75%

Using the Gordon growth model:

Expected dividend payout = EPS x payout ratio = $5 x 0.25 = $1.25

Expected growth rate = (return on equity - dividend yield) x retention rate = (15% - 1.25/5) x 0.75 = 9.375%

The closest answer to this rate is 9.8% (answer choice B).

You Expect KT Industries (KTI)will Have Earnings Per Share of $5