The table below gives an EPS estimate for time 1 (one year from now) and project

Question

The table below gives an EPS estimate for time 1 (one year from now) and projected retention ratios and returns on investment through time 6. The expected return on investment listed in a given year helps determine EPS growth in the next year. Assuming EPS and dividend growth from year 5 to year 6 will continue indefinitely and that the cost of equity is 12%.

times 0 1 2 3 4 5 6
Expected EPS $4.00
Retention ratio 1.00 1.00 0.80 0.60 0.40 0.40
expected return on invest. 0.20 0.20 0.20 0.15 0.10 0.10

Suppose managers are comfortable with all the projections in the table except the retention ratios. To maximize share prices, managers should
a. Pay out all earnings beginning in year 1.
b. Retain all earnings beginning in year 1.
c. Retain earnings so long as expected returns on investment exceed the cost of equity.
d. Pay out earnings so long as expected returns on investment exceed the cost of equity.

Explanation / Answer

c. Retain earnings so long as expected returns on investment exceed the cost of equity.

Related Questions

Navigate

• Browse (All)
• Browse T
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.