Question

Company X had EPS of $10 and paid out $4 dividend this year. The market required return for the stock is 16% .

Which of the following statements is not correct?

Select one:

a. The stock's current retention ratio is 60%

b. The stock's current payout ratio is 40%

c. If the company retains more earnings for new investment, its stock value will increase.

d. If the expected new return on firm's invested capital (NROIC) is 20%, its earnings is expected to grow by 12%.

Answer 1

- Dividend Payout ratio = Dividend/EPS

= $4/$10 = 40%

Retention ratio = 1- Dividend payout ratio

= 1-0.40

= 0.60 or 60%

So, Option (a) and (b) are correct.

- When company retains more earnings it increases firms Retention ratio which further increase firms growth rate.

As, Growth rate = ROE*Retention ratio

So, increase in growth rate increases the stock value. So, part (c) is also correct.

Hence, Part(d) is incorrect.

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