DFB, Inc. expects earnings this year of $5 per share, and it plans to pay a $3

Question:

DFB, Inc. expects earnings this year of $5 per share, and it plans to pay a $3 dividend to shareholders. DFB will retain $2 per share of its earnings to reinvest in new projects that have an expected return of 15% 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.

a. What growth rate of earnings would you forecast for DFB?

b. If DFB’s equity cost of capital is 12%, what price would you estimate for DFB stock?

c. Suppose instead that DFB paid a dividend of $4 per share this year and retained only $1 per share in earnings. 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?

Cost Of Capital
Cost of capital refers to the opportunity cost of making a specific investment . Cost of capital (COC) is the rate of return that a firm must earn on its project investments to maintain its market value and attract funds. COC is the required rate of... Dividend
A dividend is a distribution of a portion of company’s earnings, decided and managed by the company’s board of directors, and paid to the shareholders. Dividends are given on the shares. It is a token reward paid to the shareholders for their... Expected Return
The expected return is the profit or loss an investor anticipates on an investment that has known or anticipated rates of return (RoR). It is calculated by multiplying potential outcomes by the chances of them occurring and then totaling these...

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