Question

P 7-16 (book/static) O DFBine expects earnings not year of 15 per har dit plans to pay a $3.00 dividend to shareholders assume that is one year from now OFE were 200 per share of its restores in new projects that have an expected eum of 15.0 per year. Suppose DFB will maintain the same dividend payout retention and return on new ements in the Mure and we hagember land was A d ivided in one What growth rate of earrings would you forecast for DFB? b. OFB's guy cost of capitalis 120, a price would you estimate for DFB ? Suppor ted that DFB pada dividend of 1400 per here at the end of this year and retained only $1.00 per share in carings. That is chose to pay a higher dividend vesting in many new projects of higher payout in the future, what a price would you for the time ? Should DFB seits dend?

Answer 1

a]

growth rate = retention ratio * rate of return on new projects.

retention ratio = (retained earnings per share / earnings per share)

retention ratio = $2 / $5 = 40%.

growth rate = 40% * 15% = 6%.

b]

Price of stock = next year dividend / (cost of capital - growth rate)

Price of stock = $3 / (12% - 6%)

Price of stock = $50

c]

growth rate = retention ratio * rate of return on new projects.

retention ratio = (retained earnings per share / earnings per share)

retention ratio = $1 / $5 = 20%.

growth rate = 20% * 15% = 3%.

Price of stock = next year dividend / (cost of capital - growth rate)

Price of stock = $4 / (12% - 3%)

Price of stock = $44.44.

It should not raise the dividend because the price of stock is lower if the dividend is raised.