Answer:
a) Growth rate of earnings
using the sustainable growth rate formula which is the maximum growth rate that a company can sustain without external financing:
Growth rate = ROE * (1 - retention rate)
= 15% * (1 - 40%)
= 15% * 60%
= 9%
(Retention rate = 2/5 * 100 = 40%)
b) Price of equity using dividend growth model:
P₀ = D₀ (1 + g) / (re – g)
D₀ = the current dividend (whether just paid or just about to be paid) = $3
g = the expected dividend future growth rate = from A above (9%)
re = the cost of equity = 12%
= 3 (1 + 0.09) / (0.12 - 0.09)
= $109
c) Price of equity
P₀ = D₀ (1 + g) / (re – g)
= 4 (1 + 0.09) / (0.12 - 0.09)
= $145.33
Explanation:
At the estimated growth rate of 9%, should DFB increase the dividend payout, the price of equity would amount to $145.33 which is higher than the previous price of $109, so DFB is advised to raise its dividend
