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 with 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 DFB instead 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 now? Should DFB raise its dividends.