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DFB, Inc. expects earnings this year of $4.49 per share, and it plans to pay a $2.55 dividend to shareholders at that time (o

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Answer #1

Answer a.

Retention Ratio, b = Earnings Retained / Expected Earnings
Retention Ratio, b = $1.94 / $4.49
Retention Ratio, b = 0.4321

Return on Equity, ROE = 15.40%

Growth Rate, g = ROE * b
Growth Rate, g = 15.40% * 0.4321
Growth Rate, g = 6.7%

Answer b.

Cost of Capital, k = 11.50%
Expected Dividend, D1 = $2.55

Current Price, P0 = D1 / (k - g)
Current Price, P0 = $2.55 / (0.115 - 0.067)
Current Price, P0 = $2.55 / 0.048
Current Price, P0 = $53.13

Answer c.

Retention Ratio, b = Earnings Retained / Expected Earnings
Retention Ratio, b = $0.94 / $4.49
Retention Ratio, b = 0.2094

Return on Equity, ROE = 15.40%

Growth Rate, g = ROE * b
Growth Rate, g = 15.40% * 0.2094
Growth Rate, g = 3.2%

Cost of Capital, k = 11.50%
Expected Dividend, D1 = $3.55

Current Price, P0 = D1 / (k - g)
Current Price, P0 = $3.55 / (0.115 - 0.032)
Current Price, P0 = $3.55 / 0.083
Current Price, P0 = $42.77

No, DFB should not raise dividends because companies should always reinvest as much as possible.

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