luation)  Assume the​ following:   •   the​ investor's required rate of return is 12.5 ​percent, •   the expected level of earnings at the end of this year ​(E1​) is ​$14​, •   the retention ratio is 45

Essentials Of Investments
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ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
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Chapter1: Investments: Background And Issues
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Common stock​ valuation)  Assume the​ following:
 
•  
the​ investor's required rate of return is
12.5
​percent,
•  
the expected level of earnings at the end of this year
​(E1​)
is
​$14​,
•  
the retention ratio is
45
​percent,
•  
the return on equity
​(ROE​)
is
15
percent​ (that is, it can earn
15
percent on reinvested​ earnings), and
•  
similar shares of stock sell at multiples of
9.565
times earnings per share.
 
​Questions:
 
a.  Determine the expected growth rate for 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​/E1​)
and stock price if the company increased its retention rate to
60
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 learned about the relationship between the retention rate and the ​P/E​ ratios?
 
 
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