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In: Finance

Bastion Inc., expects earnings this year of $5 per share and is paying a dividend of...

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.

Expert Solution

Solution:

Bastion Inc. expects earnings this year of $5 per share, and it plans to pay a $1 dividend to
shareholders. Bastion Inc. will retain $4 per share of its earnings to reinvest in new projects that
have an expected return of 12% per year. Suppose Bastion Inc. 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 Bastion Inc.?

answer =9.6%

= retension rate x return on invet= 4/5 x12%= 9.6%

(b) If Bastion's equity cost of capital is 11.2%, what price would you estimate for Bastion stock?

answer = 62.5 DOLLARS

= 1/(11.2%- 9.6%) = 62.5

c) Suppose instead that Bastion Inc. paid a dividend of $2 per share this year and retained only $3
per share in earnings. If Bastion Inc. maintains this higher payout rate in the future, what stock price
would you estimate for the firm now? Should Bastion Inc. raise its dividend?

= 3/5 x12%=7.2%

P= 2/(11.2%- 7.2%) = 50 DOLLARS

Should DFB raise its dividend?

no

positive NPV

jeff jeffy answered 2 years ago

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