XYZ expects to have earnings per share of $5 in the coming year. Rather than reinvest these earnings and grow, the firm plans to pay out all of its earnings as a dividend. With these expectations of no growth, XYZ’s current share price is $55. Suppose XYZ could cut its dividend payout rate to 40% for the foreseeable future and use the retained earnings to open new stores. The return on investment in these stores is expected to be 15%. If we assume that the risk of these new investments is the same as the risk of its existing investments, then the firm’s equity cost of capital is unchanged. What effect would this new policy have on XYZ’s stock price?
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