DFB, Inc. expects earnings next year of $4.03 per share, and it plans to pay a $
ID: 1172198 • Letter: D
Question
DFB, Inc. expects earnings next year of $4.03 per share, and it plans to pay a $1.69 dividend to shareholders (assume that is one year from now). DFB will retain $2.34 per share of its earnings to reinvest in new projects that have an expected return of 14.3% 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. Assume next dividend is due in one year a. What growth rate of earnings would you forecast for DFB? b. If DFB's equity cost of capital is 1 1.8%, what price would you estimate for DFB stock? c. Suppose instead that DFB paid a dividend of $2.69 per share at the end of this year and retained only $1.34 per share in earnings. That is, it a. What growth rate of earnings would you forecast for DFB? DFB's growth rate of earnings is.%. (Round to one decimal place.)Explanation / Answer
a)
Growth rate = retention * return on new investments
Growth rate = 2.34 / 4.03 * 0.143
Growth rate = 0.08294 or 8.3%
b)
Price for DFB stock = 1.69 / 0.145 - 0.083
Price for DFB stock = $27.26
c)
Growth = retention ratio * return on equity
Growth = 1.34/4.03 * 0.145 = 0.0482 or 4.8%
Price = 2.69 / 0.145 - 0.048
Price = $27.73
No it should not as returns exceeds cost of capital
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