DFB, Inc. expects earnings next year of $5.02 per share, and it plans to pay a $
ID: 2760496 • Letter: D
Question
DFB, Inc. expects earnings next year of $5.02 per share, and it plans to pay a $2.80 dividend to shareholders. DFB will retain $2.22 per share of its earnings to reinvest in new projects that have an expected return of 14.2% 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. What growth rate of earnings would you forecast for DFB? If DFB's equity cost of capital is 12.2%, what price would you estimate for DFB stock? Suppose instead that DFB plans to pay a dividend of $3.80 per share next year and retained only $1.22 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 for the firm now? Should DFB follow this new policy? What growth rate of earnings would you forecast for DFB? DFB's growth rate of earnings is 6.3 %. (Round to one decimal place.) If DFB's equity cost of capital is 12.2%, what price would you estimate for DFB stock? If DFB's equity cost of capital is 12.2%, then DFB's stock price will be $ 47.46. (Round to the nearest cent.) Suppose instead that DFB plans to pay a dividend of $3.80 per share next year and retained only $1.22 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 for the firm now? If DFB paid a dividend of $3.80 per share next year and retained only $1.22 per share in earnings, then DFB's stock price would be $ (Round to the nearest cent.)Explanation / Answer
a)Dividend payout ratio=2.80/5.02
plowback ratio=1-Dividend payout ratio=1-(2.80/5.02)=2.22/5.02
Return on equity=14.2%=0.142
growth rate=Return on equity*plowback ratio
growth rate=0.142*(2.22/5.02)=0.062797=6.3%
b)Price=Dividend in 1 year/(equity cost of capital-growth rate)
if growth rate is not rounded: Price=2.80/(0.122-0.062797)=$ 47.29
if growth rate taken is rounded value: Price=2.80/(0.122-0.063)=$ 47.46
c)
Dividend payout ratio=3.80/5.02
plowback ratio=1-Dividend payout ratio=1-(3.80/5.02)=1.22/5.02
Return on equity=14.2%=0.142
growth rate=Return on equity*plowback ratio
growth rate=0.142*(1.22/5.02)=0.0345=3.45%
Price=3.80/(0.142-0.0345)=$ 35.35
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