Question

Aaron Inc. has 321 million shares outstanding. It expects earnings at the end of the year to be

$641 million. The firmʹs equity cost of capital is 11%. Aaron pays out 50% of its earnings in total:
30% paid out as dividends and 20% used to repurchase shares. If Aaronʹs earnings are expected
to grow at a constant 7% per year, what is Aaronʹs share price?

Answer 1

To find Aaron Inc.'s share price, the Gordon Growth Model is used with the formula P = D / (k - g). The expected dividends per share are calculated, and with a growth rate of 7% and a cost of equity of 11%, the calculation results in a share price of $14.975.

Step-by-step explanation:

To calculate Aaron Inc.'s share price using the given financial information, we need to use the Gordon Growth Model (also known as the Dividend Discount Model), which is used to determine the price of a stock based on its future series of dividends that grow at a constant rate.

The model assumes that dividends will increase at a consistent growth rate indefinitely. The formula for the model is P = D / (k - g), where P is the current stock price, D is the dividend per share one year from now, k is the cost of equity capital, and g is the growth rate of dividends.

Aaron Inc. has expected earnings of $641 million and will pay out 50% of its earnings, with 30% as dividends. Therefore, the dividend payout will be 30% of $641 million which equals $192.3 million.

Given there are 321 million shares outstanding, the dividend per share will be $192.3 million / 321 million shares, which equates to $0.599 per share. The dividends are expected to grow at a rate of 7%. To find the price of the stock, we substitute the values into the formula, so: P = $0.599 / (0.11 - 0.07) = $14.975 per share.