Question
DFB, Inc., expects earnings at the end of this year of $4.47 per share, and it plans to pay a $2.44 dividend at that time.
DFB, Inc., expects earnings at the end of this year of $4.47 per share, and it plans to pay a $2.44 dividend at that time. DFB will retain $2.03 per share of its earnings to reinvest in new projects with an expected return of 14.4% 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 12.2%, what price would you estimate for DFB stock today?
c. Suppose DFB instead paid a dividend of $3.44 per share at the end of this year and retained only $1.03 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 now? Should DFB raise its dividend?
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