Bastion Inc., expects earnings this year of $5 per share and is paying a dividend of $1 today to shareholders. Bastion pays an annual dividend. Bastion will retain $4 pershare of its earnings to reinvest in new projects that have a return of 12% per year. Suppose Bastion will maintain the same dividend payout rate, retention rate, and return on new investments in the future and will not change its number of outstandingshares.
(a) What growth rate of earnings would you forecast for Bastion?
(b) If Bastion’s equity cost of capital is 11.2%, what price would you estimate for Bas-tion’s stock? Assume that investors will receive today’s dividend when estimatingthe stock price.
(c) Suppose instead that Bastion paid a dividend of $2 per share this year and retainedonly $3 per share in earnings. If Bastion maintains this higher payout rate in the future, what stock price would you estimate for the firm now? Should Bastion raise its dividend? Assume that investors will receive today’s dividend when estimating the stock price.