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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?

#### 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.

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