This Question: 1 pt 30f 10 (2 complete) This Quiz: 10 pts possible OFB, Inc. exp

Question

This Question: 1 pt 30f 10 (2 complete) This Quiz: 10 pts possible OFB, Inc. expects earnings next year of $5.52 per share, and it plans to pay a $3.95 dividend to shareholders (assume that is one year from now). DFB will retain $1.57 per share of its earnings to reinvest in new projects that have an expected return of 4 2 % per ear uppose F wl maintain he same di den payout rate retention rate and return on new n est en s n efn re and w not c ange ts nun bero outstanding shares. Assume next den sdue none ear. a. What growth rate of earings would you forecast for DFB? b. If DFB's equity cost of capital is 11.1%, what price would you estimate for DFB stock? c. Suppose instead that DFB paid a dividend of $4.95 per share at the end of this year and retained only $0.57 per share in earnings. That is, it chose to pay a higher dividend instead of reinvesting in aa 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 raise its dividend? a. What growth rate of eamings would you forecast for DFB? OFB's growth rate of earnings is (Round to one decimal place.) b. If DFB's equity cost of capital is 11.1%, what price would you estimate for DFB stock? lf DFB's equity cost of capital is 1 1.1%, then DFB's stock price wil be $1 . (Round to the nearest cent.) c. Suppcse instead that DFB paid a dividend of $4.95 per share at the end of this year and retained only $0.57 per share in earnings. That is, it chose to pay a higher dividend instead of reinvestng in as many new projects. If DFB maintains this highe payout rate in the future, what stock price would you estimate for the firm now? If DFB paid a dividend of S4.95 per share next year and retained only $0.57 per share in earnings, then DFB's stock price woukd be $ Round to the nearest cent.) Should DFB raise its dividend? (Select the best choice below.) O A. Yes, DFB should raise divicends because, according to the dividend-d scount model, doing so will always improve the share price. O B. ° C. No, DFB should not raise dividends because the projects are positive NPV No, DFB should not raise dividends because companies should always reinvest as much as possible. D. Yes. DFB should raise dividends because the return on new investments is lower than the cost of capital.

Explanation / Answer

a) Growth rate = ROE x Retention Ratio

Retention Ratio = 1.57 / 5.52 = 28.44%

=> Growth rate, g = 14.2% x 28.44% = 4.04%

b) Stock Price, P = D1 / (r - g) = 3.95 / (11.1% - 4.04%) = $55.94

c) g = 0.57 / 5.52 x 14.2% = 1.47%

P = 4.95 / (11.1% - 1.47%) = $51.38

d) C appears plausible because higher dividend payout leads to lower share price.

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