In March of 2005, Domestic Paper stock sold for $73. Security analysts were forecasting a long-term earnings growth rate of 8.5%. The company was paying dividends of $1.68 per share.

a. If dividends are expected to grow along with earnings at g = 8.5% per year in perpetuity, what rate of return, rE, were investors expecting?

b. If instead Domestic Paper is expected to earn 12% on book equity (ROE) and to retain 50% of its earnings. Based on these new forecasts and the current $73 price, recalculate g and rE?