Expected dividend (EOC)?

CFA Level I Corporate Finance
#1

All,

Can someone please help me to calculate the expected dividend?

Given –

Stock price = $28

Current dividend on $28 = $2

Expected dividend payout rate = 40%

Expected ROE = 15%

Official answer = 2.18.

Here’s what I did:-

Expected dividend = Current Stock price * Expected ROE * Expected Dividend payout rate = 28*.15* .4 = 1.68. (Intuitive, multiplying ‘expected ROE’ will tell me future returns on the current stock price; Further multiplying with ‘expected dividend payout rate’ will tell me the future dividend. Alas, I am wrong.)

What am I missing here? Can someone please help me?

Thanks in advance.

#2

You compute the growth rate first, ROE x Retention ratio. Retention ration is 1- dividend payout ratio. 0.15(1-0.4) = 0.9. Expected dividend is Current Divdend(1+growth rate) = 2(1.09) = 2.18. Hope it helps.

#3

Ok - I see. However, I also did this — Expected Dividend = Expected Stock Price * Dividend Payout rate = 28*(1.09)*0.4 =12.208. Why is this wrong? Can you or someone else please explain this to me?

Thanks in advance

#4

I think the growth rate shall be for stock dividend, not for stock price.

#5

Firstly, I truly appreciate your response. However, I believe not so because the dividend is a percentage of the stock price. Hence, mathematically, both should grow at the same rate. I hope I am not coming across as argumentative.

Example — Let’s say I ate 5% (Dividends) of the fruits (stock) I bought today. Tomorrow, if I buy additional fruits, say 5%, and my eating is at a constant rate, I will know how many fruits I will eat tomorrow.

#6

I think its wrong because dividends aren’t computed based on stock price, and stock prices are determined by market forces, the formular is intuitive, expected payout is based on the current payout * growth rate(which is computed based on the rate of the amount they retain, i.e. the amount they set aside to help propagate the activies of the business to make it more profitable, multiplied by their return (on equity).

#7

So, it seems our friend, Asuka, was right. The bottomline is that the computed growth rate is only applicable to the dividend and not the stock price. However, this is untuitive to me, at least mathematically : because if dividends are a percentage of the stock price, and if I can compute future dividends based on today’s dividends and growth rate, I should be able to compute the expected growth rate. Here’s the equation:

Div = Stock * P, where P = percentage of STock price.

If Div becomes Div *1.09, then we know that Stock will become Stock *1.09 because P is constant. What am I missing here? I knwo that Stock prices are determined by market forces but Dividends are also the result of market forces (as in they are a fixed percentage of the stock price, which are determined by market forces!)

What am I missing here? Please help me. Thanks in advance.

#8

why dividends are the result of market forces? can you elaborate further?

#9

I am sorry for reopening this thread… I have two questions based on what we are discussing :

#1 - In equation, g = Retention Rate * ROE, if g = dividend growth rate, then what is the growth rate of the equity?

#2- Stock prices are the result of market forces. Now if, dividends are a percentage of the stock prices, then dividends are also implicitly the result of market forces. Thus, the dividend growth rate shoudl be determined by the growth rate of the stock. Isn’t it?

Can any of the experts confirm this?

Thanks in advance.

#10
  1. G= growth rate of the company(I’m yet to read about growth rate of equity) a product of the return on equity and the amount they retain in the business to make it more profitable. 2. To the best of my knowledge, Dividends aren’t a percentage of stock price.