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7 DFB Inc expects earnings next year of 4 22 per share and it plans to pay a 2 13 dividend to shareholders DFB will retain 2 09 per share of its earnings to reinvest in new projects that have an expected return of 15 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 DFB s growth rate of earnings is Round to one decimal place b If DFB s equity cost of capital is 12 9 then DFB s stock price will be nearest cent Round to the c Suppose instead that DFB plans to pay a dividend of 3 13 per share next year and retained only 1 09 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 DFB s stock price would be Round to the nearest cent Should DFB follow this new policy a No DFB should not raise dividends because companies should always reinvest as much as possible b Yes DFB should raise dividends because the return on new investments is lower than the cost of capital c Yes DFB should raise dividends because according to the dividend discount model doing so will always improve the share price d No DFB should not raise dividends because the projects are positive NPV

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