Let me know what you guys make of this question its got me a little confused
A company currently has a required return on equity of 14% and an ROE of 12%. All else equal, if there is an increase in a firm’s dividend payout ratio, the stock’s value will most likely:
A) increase.
B) either increase or decrease.
C) decrease.
The answer is A in Qbank, but I thought it would be C since the growth rate decreases, decreasing the denominator.
I’m sure I’m just not grasping something easy but an explanation would be greatly appreciated.
Thanks in advance作者: willsucceed 时间: 2013-4-6 22:08
the question doesn’t say anything about growth rate decreasing.作者: RobertA 时间: 2013-4-6 22:08
g=b * ROE
b = (1Div Payout)
if Div Payout Increases (1b) decreases, b increases
with ROE the same g = b * ROE increases.
With r the same (rg) decreases
so numerator E1 * B increases
(rg) in the denominator decreases.
So both factors result in a Valuation increase.作者: kmf229 时间: 2013-4-6 22:08
CPK,
if the dividend pay out increases, then b should decrease. I’m not sure why u said b increases….
I think the reasoning is as follows (assuming all else is constant):
If payout increases, the company retains less for reinvestment, so retention ratio (b) decreases
since b decreases, growth (g) decreases as (remember the formula g=b*ROE)
As a result (rg) increase….but also keep in mind that Div payout also increased as stated by the question.
Since the numerator (div payout) and the denominator (rg) increases, the price will increase as well. Pure arithmetic here.
So the answer is A.作者: Windjammer 时间: 2013-4-6 22:08
I got that part wrong. definitely was not thinking right.
Since the numerator has a (1+g) on it, it will be a higher number than the denominator (rg) which is
Sorry about the wrong response earlier.
