Question

the investor's required rate of return is 13.5 percent the expected level of earnings at the end of this year (E1) s $6, the retention ratio is 40 percent, the return on equity (ROE) is 13 percent (that is, it can earn 13 percent on reinvested earnings), and similar shares of stocks sell at multiples of 7.228 times earnings per share Questions a. Determine the expected growth rate for the dividends. b. Determine the price earnings ratio (P/E1) c. What is the stock price using the P/E ratio valuation method? d. What is the stock price using the dividend discount model? e. What would happen to the P/E ratio (P/E (P/E1) and stock price if the company increase it retention rate to 75 percent (holding all else constant)? What would happen to the P/E ratio (P/E1) and stock price if the company paid out all its earnings in the form of dividends? f. What have you leaned about the relationship between the retention rate and the P/E ratios? a. What is the expected growth rate for dividends?.

Answer 1

Given,

Required rate of return (r) = 13.5% or 0.135

Expected earnings per share (E1) = $ 6

Retention ratio = 40% or 0.40

Return on equity (ROE) = 13%

Solution :-

(a Expected grouwth rate Rr dividends() Retention ratio x Return on eguity -1 S.R or 0.O5R 40% 13% 1 (पो Ine queshion, Similar shares of at multiples of 7.328 Stochs Sellg imes eolznigs per share the price igure 7.228 Js Phe carning atio ie, P/E Stock Pnce sing PE atio Valuation methed= PIE ato x Earnings per share E1) X $6 7.२२४ $43.368

Expected Dividend (D,) E, x(1-Retention rato) 2$6 x(1 0. Чо) 3.6 F6 x0.60 Now Stock Pntce using Dividerd Discound model D, $3.6 O.135-0.052 $3.6 0.083 $43.37 (