Question: If ROE > rS, then a company will increase shareholder value (stock price will go up) when retaining earnings and reinvesting them within the company.

If ROE > rS, then a company will increase shareholder value (stock price will go up) when retaining earnings and reinvesting them within the company. Assume a firm has ROE = 20% and rS=15%. Next period's earnings (E1) will be $8 per share. Calculate the share price if the firm retains 25% of its earnings (and pays out 75% as a dividend).

Calculate the share price if the firm retains 50% of its earnings (and pays out 50% as a dividend). What is the difference in price?

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To calculate the share price we can use the Gordon Growth Model P D1 E1 x retention ratio rS ... View full answer

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