Asked by Marissa Gonçalves on Jun 05, 2024
Verified
Salted Chips Company paid a dividend last year of $2.50. The expected ROE for next year is 12.5%. An appropriate required return on the stock is 11%. If the firm has a plowback ratio of 60%, the dividend in the coming year should be
A) $1.00.
B) $2.50.
C) $2.69.
D) $2.81.
E) None of the options are correct.
ROE
Return on Equity indicates a company's return from shareholder investments by showcasing the profit made from each dollar invested by shareholders.
Required Return
The minimum expected return an investor demands for holding a particularly risky investment, influenced by the risk-free rate and the risk premium.
- Understand the relationship between growth rates, required returns, and dividend payout ratios in valuing stocks.
Verified Answer
BD
Bavan DhindsaJun 11, 2024
Final Answer :
C
Explanation :
The dividend next year can be calculated using the formula for dividend growth, which incorporates the plowback ratio (b) and the return on equity (ROE). The growth rate (g) is b * ROE = 0.60 * 12.5% = 7.5%. The expected dividend next year is then last year's dividend * (1 + g) = $2.50 * (1 + 0.075) = $2.6875, which rounds to $2.69, making option C correct.
Learning Objectives
- Understand the relationship between growth rates, required returns, and dividend payout ratios in valuing stocks.