A firm that pays out 65% of its earning as dividend has an accounting rate of return of 20%. Its P/E ratio is 10 and earnings per share is 108 cents.
I. What is the price per share?
II. What is the dividend yield?
III. If shares were bought, what would be the payback period? Assume the only return is the dividend.
IV. What is the net book value per share of the asset investment of the company?
V. If the risk-adjusted required rate of return is 6%, what would be the NPV per share for buying shares?
VI. Would you buy shares using AROR or NPV?
Solution
I. What is the price per share?
P/E ratio x earnings per share = 10 x 108 = $10.80

II. What is the dividend yield?
Yield = Dividend/Share price = 65%/$10.80 = 6.01%

are my answers correct? Able to advice how to go about the rest?

I. Is correct.

For II, dividend yield is calculated by dividing the actual dividend---not the payout rate---by the share price. The actual dividend is found by multiplying the earnings per share by the payout rate.

The 'payback' asked for in III is the length of time it would take to recover the share price in the form of dividends. For example, if I pay $7.50 for a share of stock, and I receive a 75 ¢ dividend every year, it'll take me exactly 10 years to get back my full investment amount by way of the dividends.

In IV, use the fundamental relationship

Net Book Value Per Share times AROR = EPS.

Since you're given AROR and EPS you can solve for NBVPS.

For V, you assume the dividend payout is a perpetuity. There's a simple formula for pricing a perpetuity, when given the annual dividend amount and the appropriate discount rate (risk-adjusted ROR). It's most likely in your text; if not, Google for "present value of a perpetuity".

The answer to VI is the answer to the question, "Which method more accurately captures the true economic value of an asset?" I'm betting this is discussed in your text.

I. is correct.

For II, dividend yield is calculated by dividing the actual dividend---not the payout rate---by the share price. The actual dividend is found by multiplying the earnings per share by the payout rate.

The 'payback' asked for in III is the length of time it would take to recover the share price in the form of dividends. For example, if I pay $7.50 for a share of stock, and I receive a 75 ¢ dividend every year, it'll take me exactly 10 years to get back my full investment amount by way of the dividends.

In IV, use the fundamental relationship

Net Book Value Per Share times AROR = EPS.

Since you're given AROR and EPS you can solve for NBVPS.

For V, you assume the dividend payout is a perpetuity. There's a simple formula for pricing a perpetuity, when given the annual dividend amount and the appropriate discount rate (risk-adjusted ROR). It's most likely in your text; if not, Google for "present value of a perpetuity".

The answer to VI is the answer to the question, "Which method more accurately captures the true economic value of an asset?" I'm betting this is discussed in your text.

Thanks so much!

Anyone know what is the difference between accounting rate of return and required rate of return?