Mexican Motors stock sells for 200 pesos per share and next year’s dividend is 8.5 pesos.

Security analysts are forecasting earnings growth of 7.5% per year for the next five years.

a. Assume that earnings and dividends are expected to grow at 7.5% in perpetuity. What rate of return are investors expecting?

b. Mexican Motors has generally earned about 12% on book equity (ROE  .12) and paid out 50% of earnings as dividends. Suppose it maintains the same ROE and payout ratio in the long-run future. What is the implication for g? For r? Should you revise your answer to part

(a) of this question?

AppendixLO1