DFB, Inc. expects earnings next year of

$5.69

per share, and it plans to pay a

$3.51

dividend to shareholders (assume that is one year from now). DFB will retain

$2.18

per share of its earnings to reinvest in new projects that have an expected return of

14.2%

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

11.4%,

what price would you estimate for DFB stock?c. Suppose instead that DFB paid a dividend of

$4.51

per share at the end of this year and retained only

$1.18

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?

Question content area bottom

Part 1

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

DFB's growth rate of earnings is

enter your response here%.

(Round to one decimal place.)

Part 2

b. If DFB's equity cost of capital is

11.4%,

what price would you estimate for DFB stock?If DFB's equity cost of capital is

11.4%,

then DFB's stock price will be

$enter your response here.

(Round to the nearest cent.)

Part 3

c. Suppose instead that DFB paid a dividend of

$4.51

per share at the end of this year and retained only

$1.18

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? If DFB paid a dividend of

$4.51

per share next year and retained only

$1.18

per share in earnings, then DFB's stock price would be

$enter your response here.

(Round to the nearest cent.)

Part 4

Should DFB raise its dividend?(Select the best choice below.)

A.No, DFB should not raise dividends because the projects are positive

NPV.

B.

Yes, DFB should raise dividends because, according to the dividend-discount model, doing so will always improve the share price.

C.

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.