Juggernaut Satellite Corporation earned 19 million for the f

Juggernaut Satellite Corporation earned $19 million for the fiscal year ending yesterday. The firm also paid out 20 percent of its earnings as dividends yesterday. The firm will continue to pay out 20 percent of its earnings as annual, end-of-year dividends. The remaining 80 percent of earnings is retained by the company for use in projects. The company has 2 million shares of common stock outstanding. The current stock price is $95. The historical return on equity (ROE) of 10 percent is expected to continue in the future. What is the required rate of return on the stock? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) Rate of return %

Solution

Year-end earnings = $ 19,000,000

Earnings per share (EPS) = Total earnings/No. of shares outstanding

                                       = $ 19,000,000/2,000,000

                                       = $ 9.5

Retention ratio = 80 % or 0.8

Current stock price, P₀ = $ 95

Return on equity, ROE = 10 % or 0.1

Dividend growth rate, g = ROE x retention ratio

                                   = 0.1 x 0.8 = 0.08 or 8 %

Year-end dividend, D₁ = EPS x (1+g) x dividend payout rate

                                 = $ 9.5 x 1.08 x 0.2 = $ 2.052

Required rate of return = (D₁ / P₀) + g

                                          = ($ 2.052 /$ 95) + 0.08

                                           = 0.1016 or 10.16 %