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Question - Baby Books expects to have earnings of $8 per share next year and plans to pay out 25% of its earnings as a dividend. All retained earnings will be reinvested, and the return on reinvestment earned by Baby Books is 6%. Given all these expectations, the current stock price of Baby Books is $25. Suppose now Baby Books increases its dividend payout rate to 50% level for the foreseeable future. Assuming the equity cost of capital, rE, is unchanged, what effect this new payout policy has on the stock price? Find the new price and explain why it increases or decreases.

Reference no: EM132737346

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