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    Rate of Return

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    Company stock sells for 200 pesos per share and next year's dividend is 8.5 pesos. Security analysts are forecasting earnings growth of 7.5% per year for the next 5 years.

    a. Assume that earnings and dividends are expected to grow at 7.5% in perpetuity. What rate of return are investors expecting?

    b. The company has generally earned about 12% on book equity (roe = .12) and paid out 50% of earnings as dividends. Suppose it maintains the same roe and payout ratio in the long-run future. What is the implication for g? For r? Should you revise your answer to part (a) of this question?

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    Solution Preview

    a. Price = Next year Div/(r-g)

    Here Price = 200
    Next year Div = 8.5
    g = .075
    Thus putting these values in the above formula we ...

    Solution Summary

    The solution explains how to calculate rate of return and impact growth rate can have on stock prices.