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Homework answers / question archive / DFB, Inc
DFB, Inc. expects earnings next year of $5.95 per? share, and it plans to pay a $3.52 dividend to shareholders? (assume that is one year from? now). DFB will retain $2.43 per share of its earnings to reinvest in new projects that have an expected return of 15.6% 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 11.6%?, what price would you estimate for DFB stock? today?
c) Suppose instead that DFB paid a dividend of $4.52 per share at the end of this year and retained only $1.43 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 raise its? dividend?
a) Computation of the growth rate:-
Retention ratio = Retained earnings / Earnings per share
= $2.43 / $5.95
= 40.84%
Growth rate = ROE * Retention ratio
= 15.6% * 40.84%
= 6.37%
b) Computation of the price of stock:-
Stock price = D1 / (Cost of equity - Growth rate)
= $3.52 / (11.6% - 6.37%)
= $3.52 / 5.23%
= $67.32
c) Computation of the price of stock:-
Retention ratio = Retained earnings / Earnings per share
= $1.43 / $5.95
= 24.03%
Growth rate = ROE * Retention ratio
= 15.6% * 24.03%
= 3.75%
Stock price = D1 / (Cost of equity - Growth rate)
= $4.52 / (11.6% - 3.75%)
= $4.52 / 7.85%
= $57.57
Correct option is C) No, DFB should not raise dividends as companies should always reinvest as much as possible.
