Spencer Supply’s stock is currently selling for $60 a share. The firm is expected to earn $5.40 per share this year and to pay a year-end dividend of $3.60.

a. If investors require a 9% return, what rate of growth must be expected for Spencer?

b. If Spencer reinvests earnings in projects with average returns equal to the stock’s expected rate of return, then what will be next year’s EPS? (Hint: gL 5 ROE 3 Retention ratio.

a. 4.5%

b. $5.643

Explanation:

a. Current Selling price is $60 per share, earnings per share is $5.40, dividend in year end is $2.70. Required rate of return is 9%.

Calculate the growth rate as follows:

Growth rate=

=9%- $2 70/$60

= 9% - 0.045

= 9% - 4.5%

=4.5%

b. If Spencer reinvests earnings in projects with average returns equal to the stock's expected rate of return.

Calculate the next year's EPS as follows:

Next year EPS = Current EPS X (I + Growth)

=$5.40 x (1 + 4.5%)

=$5.40 x (1 + 0.045)

=$5.40 x (1.045)

$5.643

Therefore, the next year earnings per share (EPS) will be

$5.643