Dauterive Barber Shops (DBS) specializes in providing quick and inexpensive haircuts for middle-aged men. The company retains about half of its earnings each year and pays the rest out as a dividend. Recently, the company paid a $3.25 dividend. Investors expect the company’s dividends to grow modestly in the future, about 4 percent per year, and they require a 9 percent return on DBS shares. Based on next year’s earnings forecast, what is DBS’s price/earnings ratio? How would the price/earnings ratio change if investors believed that DBS’s long-run growth rate was 6 percent rather than 4 percent? Retaining the original assumption of 4 percent growth, how would the price/earnings ratio change if investors became convinced that DBS was not very risky and were willing to accept a 7 percent return on their shares going forward?
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