Given that the beginning value on a stock is $640, expected earnings are $80, the retention rate of earnings is 40%, and the required rate of return is 21%, what is the minimum expected ending value of the stock that makes it a profitable investment?
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A. B. C. D. E.D
The dividend payout ratio is equal to one minus the retention rate (1 - 0.4 = 0.6). Expected dividends are equal to the dividend payout ratio multiplied by expected earnings (0.6 x 80 = $48). In order for a stock to be a good investment, its rate of return should be equal or greater than the required rate of return.The minimum ending value that would make the stock investment in this question profitable is given by the equation (P2 + D) / P1 = 1 + k, where P2 is the ending value, P1 is the beginning value, D is the expected dividend, and k is the required rate return. Rearranging this yield P2 = ((k + 1) x P1) - D. In this question, the minimum ending value is (1.21 x 640) - 48 = $726.40.