Question

Question 6
Suppose that the consensus forecast of security analysts of your favorite company is that earnings next year will be $5.00 per share. The company plows back 50% of its earnings and if the Chief Financial Officer (CFO) estimates that the company's return on equity (ROE) is 16%. Assuming the plowback ratio and the ROE are expected to remain constant forever:

Suppose that you are confident that 10% is the required rate of return on the stock. What does the market price of $50.00 per share imply about the market’s estimate of the company’s expected return on equity? (please give a number)

*Make sure to input all percentage answers as numeric values without symbols, and use four decimal places of precision. For example, if the answer is 6%, then enter 0.0600.

Answer 1

Answer:

$250

Step-by-step explanation:

according to the constant dividend growth model

price = d1 / (r – g)

d1 = next dividend to be paid

r = cost of equity

g = growth rate

Sustainable growth rate is the rate of growth a company can afford in the long term

sustainable growth rate = plowback rate x ROE

b = plowback rate. It is the portion of earnings that is not paid out as dividends

g = 0.50 x 0.16 = 0.08 = 8%

5 / (10% – 8%)

5 / 2%

5 / 0.02 = $250

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Answer 2

Answer:

0.1000

Explanation:

W.K.T PV = E ( 1 - b ) / r - (b * ROE)

Here, we need to find ROE, but g = b*ROE

So, substitute b * ROE  as g in this equation.

PV = 50, b = 0.5, ROE = 0.16 and r = 0.1

We get g = 0.05

Now, ROE = g / b

Which is, ROE = 0.05 / 0.5 = 0.1