An investor purchased stock in a company for $20 at the end of a year for which the company reported EPS for $4.00. Due to capitla investment needs, the company retains 75% of earnings and intends to maintain this retention rate in the future. ROE is constant at 33.3%. If the expected price of the stock in 1 year is $25, the expected 1-year holding period return on this stock is: A. 12.25% B. 24.00% C.28.50% D. 31.15% My calculation: g=ROE*RR=33.3%*0.75=24.98% Dividend paying out= EPS*(1-RR)=4*0.25=1 r=Div(1+g)/price($25)+24.98%=1.2498/25+0.2498=29.97% ( none of the answers!) The answer given is D. What is wrong in my calculation? Thanks a lot! R
P(purchase) = 20 EPS(at the time of purchase) = 4 RR = 0.75 ROE = 0.333 g = RR * ROE = 0.75*0.333 =0.24975 P1 = 25 D0 = EPS*0.25 D0 = 4*0.25 = 1 D1 = D0*(dividend growth rate) D1 = 1*(1 + 0.25) D1 = 1.25 (expected) HPR for 1 year = (P1 - P0 + D1)/P0 HPR = (25 - 20 + 1.25)/20 HPR = 6.25/20 HPR = 0.3125 = 31.25% = D Let me know if this makes sense? - Dinesh S
dinesh, super - would have resolved it the same way but too tired of typing it now… lol answer is d
yeah, you are right! there is no need making things complicated! what was I thinking… haha, must have done too many DDM questions. Thanks Dinesh!