USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Assume that the dividend payout ratio will be 45 percent when the rate on long-term government bonds falls to 9 percent. Because investors are becoming more risk averse, the equity risk premium will rise to 7 percent and investors will require a 16 percent return. The return on equity will be 14 percent.
-Refer to Exhibit 9.4. To what price will the market rise if the earnings expectation is $10.00?
A) $71.40
B) $66.30
C) $54.20
D) $77.00
E) $51.10

Question

Quizplus · Accepted Answer

The price can be calculated using the Gordon Growth Model: P = D / (r - g). The dividend (D) is 45% of $10, which is $4.50. The required return (r) is 16%. The growth rate (g) is the return on equity (14%) minus the payout ratio (45% of 14%), which is 7.7%. Thus, P = $4.50 / (0.16 - 0.077) = $54.20.