Another PE Question

Assume a company’s ROE is 14% and the required return on equity is 13%. All else remaining equal, if there is a decrease in a firm’s retention rate, a stock’s value as estimated by the constant growth dividend discount model (DDM) will most likely: A) either increase or decrease. B) not change. C) increase. D) decrease.

G goes down. D


It’s good not to do the math, just like pepp did it…if growth is low (assume zero) , then clearly no one will like the stock, thus price goes down. If if growth is high (occurs when payout=0), the firm is keeping all its money in, and investors call it a growth stock, thus price up. Great!

this got me wrong b/c i thought higher div payout = higher PE so lower RR = more DP out so higher PE = higher stock, but that is faulty logic, i guess it is about the G and if you plug .5 for an RR then .4, g goes down thanks guys