If a firm reinvests 100% of its earnings (b = 1.0) into projects yielding a return on equity (RO

With b = 1, the payout ratio is 1 - b = 0, so the firm pays no dividend and D1 = 0. The dividend yield is D1/P0 = 0. The sustainable growth rate is g = b × ROE = 1.0 × 14% = 14%. Since ke = 16% is greater than g = 14%, the formula is well defined, and it gives P0 = D1/(ke - g) = 0/0.02 = 0. If shareholders never receive a dividend, a dividend discount model has no cash flows to discount. The retained earnings do create value, but the model sees it only once payouts begin. To value such a firm we need a multi-stage DDM in which the start date and size of the future dividends are stated explicitly. This is option (B). Option (A) is wrong, because the price rises without limit only when D1 is positive and ke approaches g from above, whereas here ke is well above g and D1 = 0. Option (C) is wrong, as g = 1.0 × 14% = 14%, which is exactly equal to ROE. Option (D) is wrong, because the dividend yield here is zero. Option (E) is wrong, since the required return depends on the risk of the investment and not on the dividend policy. Hence the correct option is (B).