Xavier Corporation
In her analysis of the stock of Xavier Corporation, Withers observes that it has a dividend of USD2 per share and a stock price of USD52. Two analyst interns have offered estimates of the company’s required rate of return and dividend growth rate, as shown in Exhibit 4.
Exhibit 4:
Xavier Corporation Required Rate of Return and Dividend Growth Rates (Estimates)
Intern 1 | Intern 2 | |
Required rate of return | 8.3% | 7.8% |
Growth rate, first four years | 5.0% | 4.8% |
Growth rate, beyond first four years | 3.6% | 4.0% |
Based on Exhibit 4 and Intern 1’s analysis, Xavier Corporation’s sustainable dividend payout ratio is closest to:
- 43.4%.
- 44.6%.
- 56.6%.
Solution
C is correct because it is based on the sustainable growth rate and the required rate of return:
Sustainable growth rate = (b in mature phase) × (Return on equity)
= (1 – Dividend payout) × (Return on equity)
0.036 = (1 – Dividend payout) × 0.083
Solving for the dividend payout ratio, the dividend payout = 56.627% ≈ 56.6%.
can anyone explain why they are taking ROE and required rate of return same 8.3 %
1 Answer