You expect KT Industries (KTI)will have earnings per share of $3 this year and expect that they will pay out $1.50 of these earnings to shareholders in the form of a dividend.KTI's return on new investments is 15% and their equity cost of capital is 12%.The value of a share of KTI's stock is closest to:

Question

Quizplus · Accepted Answer

To determine the value of KTI's stock using the dividend discount model, we can use the formula:

Value of stock = Dividend / (Cost of equity - Growth rate of dividends)

Here, the dividend is $1.50 (as given in the problem). The growth rate of dividends can be calculated as the product of the earnings retention ratio and the return on new investments:

Retention ratio = (Earnings - Dividend) / Earnings = (3 - 1.5) / 3 = 0.5
Growth rate of dividends = Retention ratio x Return on new investments = 0.5 x 0.15 = 0.075

Substituting these values in the formula, we get:

Value of stock = 1.5 / (0.12 - 0.075) = $33.33

Therefore, the closest value of a share of KTI's stock is $33.35 (option C).

You Expect KT Industries (KTI)will Have Earnings Per Share of $3