What Happens to a Firm That Reinvests Its Earnings at a Rate

question 23

Multiple Choice

What happens to a firm that reinvests its earnings at a rate equal to the firm's required return?

• A)its stock price will remain constant
• B)its stock price will increase by the sustainable growth rate
• C)its stock price will decline unless dividend payout ratio is zero
• D)its stock price will decline unless plowback rate exceeds required return

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Definitions:

Flotation Cost

The total costs associated with issuing new securities, including but not limited to underwriting, legal, and registration fees.

Equity Capital

Funds raised by a company through the sale of common or preferred stock, representing ownership interest in the company.

Marginal Tax Rate

The tax rate on the last unit of income.

Cost of Debt

The effective rate that a company pays on its current debt, often calculated by taking the average interest rate it pays on all of its debt instruments.