Question

In the dividend discount model, the stock price increases at the rate of dividend growth (g), and g=ROE*b. Why or why not is it always in the best interest of stockholders if a company decides to reinvest a larger portion of its net income (increasing b)? Assume constant and positive ROE.

Answer 1

Answer = The Dividend growth model is

P0 = D1 / (ke-g)

and where g is calculated as b*r

here b is retention ratio and r is return on equity

it is not always in the best interest of stockholders if a company decides to reinvest a larger portion of its net income (increasing b) because first thing is that the money of the shareholder is that when it is in their hand may be the company earn a good profit now but in future it may suffer loss then that loss was recovered from that earning so no benefits of dividend receive to the shareholder.

But if is sure that company always earn positive ROE which is always more than the shareholder expected return then it is better and in the best interest of the shareholders