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Defenestration Industries plans to pay a $4.00 dividend this year and you expect that the firm's earnings are on track to grow at 5% per year for the foreseeable future.Defenestration's equity cost of capital is 13%.
-Suppose that Defenestration decides to pay a dividend of only $2 per share this year and use the remaining $2 per share to repurchase stock.If Defenestration maintains this dividend and total payout rate,then the rate at which Defenestration's dividends and earnings per share are expected to grow is closest to:
A)7%.
B)13%.
C)9%.
D)5%.

Question

Quizplus · Accepted Answer

The correct answer is C.The dividend growth rate is equal to the retention ratio times the earnings growth rate. In this case, the retention ratio is 50% (since half of the earnings are paid out as dividends and half are used to repurchase stock). The earnings growth rate is 5%. Therefore, the dividend growth rate is 50% * 5% = 2.5%.

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