Question

Food Chain, Inc. common stock recently paid a dividend of $2.60. The firm typicallypays out 50% of its earnings as dividends and retains the rest for investment in the firm.Food Chain has a return on equity of 15 percent. If investors require a return of 12percent, what is the intrinsic value of the firm's common stock? Assume dividends will grow at a constant rate.

a) $21.67
b) $23.29
c) $62.11
e) $57.78
d) $24.92

Answer 1

Answer: c) $62.11

Step-by-step explanation:

Value of stock = Next Dividend / (Required return - Growth rate)

First calculate the growth rate;

= Return on Equity * Retention ratio

= 15% * 50%

= 7.5%

Next Dividend = 2.60 * ( 1 + growth rate)

= 2.60 * 1.075

= $2.795

Value of stock = 2.795/ (12% - 7.5%)

= $62.11