In the month of April of the current Financial Year, shares of PQR Ltd. were sold for 1,570 per share. A long-term earnings growth rate of 8% is…

(i) According to Dividend Discount Model approach, the firm's expected or required return on equity is computed as follows: K e = (D 1 /P o ) + g K e = [25 (1 + 0.08) / 1,570] + 0.08 = (27 / 1,570) + 0.08 = 0.0172 + 0.08 = 0.0972 or 9.72% (ii) With rate of return on retained earnings (r) is 10% and retention ratio (b) is 60%, new growth rate will be as follows: g = br = 0.10 × 0.60 = 0.06 Accordingly, dividend will also get changed and to calculate this, first we shall calculate previous retention ratio (b 1 ) and then EPS assuming that rate of return on retained earnings (r) is same. With previous Growth Rate of 8% and r =10%, the retention ratio comes out to be: 0.08 = b 1 × 0.10 b 1 = 0.80. So, payout ratio = 0.20 With 0.20 payout ratio the EPS will be as follows: EPS = 25 / 0.20 = 125 With new 0.40 (1 – 0.60) payout ratio, the new dividend will be D 1 = 125 × 0.40 = 50 Accordingly, new K e will be K e = (50 / 1,570) + 0.06 = 0.0318 + 0.06 = 0.0918 or, K e = 9.18%