Question

​DFB, Inc., expects earnings this year of $ 4.41 per​ share, and it plans to pay a $ 2.65 dividend to shareholders. DFB will retain $ 1.76 per share of its earnings to reinvest in new projects with an expected return of 15.1 % per year. Suppose DFB will maintain the same dividend payout​ rate, retention​ rate, and return on new investments in the future and will not change its number of outstanding shares.

a. What growth rate of earnings would you forecast for​ DFB?

b. If​ DFB's equity cost of capital is 12.7 % ​, what price would you estimate for DFB​ stock?

c. Suppose DFB instead paid a dividend of $ 3.65 per share this year and retained only $ 0.76 per share in earnings. That​ is, it chose to pay a higher dividend instead of reinvesting in as many new projects. If DFB maintains this higher payout rate in the​ future, what stock price would you estimate​ now? Should DFB follow this new​ policy? a. What growth rate of earnings would you forecast for​ DFB? Earnings growth rate will be nothing ​%. ​ (Round to two decimal​ places.)

Answer 1

Sol As given in the question - Expected Earnings - (Eds.) = $4.41. Expected Dividend - (D) $2.65. Retention Ratio te (b) = Retained Earnings Expected Earnings 1.76 4.41 = 40%. Expected Return on E(R) = 15.1% og ie b= r- growth = bxr. rentiontion ratio. – 40 %. return on eqrity - 15.1 % 2 1 % O 40% 6.04 X 15. ). & Ke As per 12.7%. constant growth DDM - ke-9 2.68 • 127 - 0604 2.65 0.0666 - $39.79 per share.

. Dividend paid - (i) = $3.65 bee share retained earnings à $0.76 per share retention ratio (be .76 4.41 z 17023). Dividend payout ratio & 3.65 4.41 282.77% = bxr O z 17.23% X 15.1 % 22.60% Po & Di Re-g 3.65 127 - 0260 3.65 Olo $ 36.14 per a share Since, return on equity is more than the reqruised rate of returia in. er > ke) hence in order to maximize the price DEB should not pay dividend.