(Q. 18 IN B) XYZ INC. REINVESTED 30% OF ITS EARNINGS IN THE CORPOR...

20. (Q. 18 in B) XYZ Inc. reinvested 30% of its earnings in the corporation. The stock sells for $25 today, and the next dividend will be $1.25 per share. The discount rate is 7.5%. What is the rate of return on XYZ Inc. equity (ROE)? A) 7.50%B) 8.33% C) 12.5% D) 22.5% Solution B We know that P

0

= D

1

/(r-g) Therefore g = r - D

1

/ P

0

Or g = 0.075 - 1.25/25 = .025 or 2.5% We also know that g = ROE x Plowback Ratio Or ROE = g / Plowback Ratio Therefore ROE = 0.025 / 0.3 = 0.0833 or 8.33% Conceptual Questions (2 points each)