USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S)
Assume that the dividend payout ratio will be 65 percent when the rate on long-term government bonds falls to 8 percent. Because investors are becoming more risk averse, the equity risk premium will rise to 7 percent and investors will require a 15 percent return. The return on equity will be 12 percent.
-Refer to Exhibit 9.1. To what price will the market rise if the earnings expectation is $22.00 per share?
A) $183.26
B) $132.41
C) $198.66
D) $71.28
E) $14.30

Question

Quizplus · Accepted Answer

The price can be calculated using the Gordon Growth Model: P = D / (r - g). The dividend (D) is 65% of $22, which is $14.30. The required return (r) is 15%. The growth rate (g) is the return on equity (12%) minus the payout ratio (65% of 12%), which is 4.2%. So, P = $14.30 / (0.15 - 0.042) = $132.41.