Juggernaut Satellite Corporation earned $18.5 million for the fiscal year ending yesterday. The firm also paid out 40 percent of its earnings as dividends yesterday. The firm will continue to pay out 40 percent of its earnings as annual, end-of-year dividends. The remaining 60 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 $80. The historical return on equity (ROE) of 14 percent is expected to continue in the future. What is the required rate of return on the stock?

13.41%

Explanation:

Last Year:  Earnings = $18,500,000

Shares Outstanding = 2,000,000

Earnings per share = Earnings / Shares Outstanding

= $18,500,000 / 2,000,000

= $9.25

Dividend per share, D0 = Earnings per share * Payout Ratio

Dividend per share, D0 = $9.25 * 40%

Dividend per share, D0 = $3.70

Retention Ratio  = 60%

Return on Equity = 14%

Growth Rate, g = Return on Equity  * Retention ratio

Growth Rate, g = 14% * 0.60

Growth Rate, g = 8.40%

Current Price, P0 = $80.00

Next Year:  Dividend per share, D1 = D0 * (1 + g)

Dividend per share, D1 = $3.70 * (1 + 8.40%)

Dividend per share, D1 = $3.70 * 1.084

Dividend per share, D1 = $4.0108

Required Rate of Return = D1 / P0 + g

= $4.0108 / $80.00 + 0.0840

= 0.0501 + 0.0840

= 0.1341

= 13.41%

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