Question

A firm has EPS of $6.20. If its retention rate is 0.7 and the expected return on new projects is 12%, at what rate will future dividends grow? Assume the firm will continue this same reinvestment policy indefinitely. Enter your answer as a decimal and show four decimal places. For example, if your answer is 4.5%, enter 0450 .

Answer 1

The future growth rate of the firm's dividends is 8.4%, calculated using the retention rate of 0.7 and the expected return on new projects of 12%.

Step-by-step explanation:

To calculate the future growth rate of a firm's dividends, we can use the Gordon Growth Model, which incorporates the firm's retention rate (b) and the expected return (r) on new projects. In this case, the earnings per share (EPS) is $6.20, the retention rate is 0.7, and the expected return is 12% or 0.12. The growth rate (g) of future dividends is calculated as the product of the retention rate and the return on new investments:

g = b × r
g = 0.7 × 0.12
g = 0.084

Therefore, the future dividends growth rate will be 0.084, or 8.4% when expressed as a decimal for the growth rate to four decimal places: 0.0840.