Question content area top Part 1 ​(Common stock​ valuation)  Assume the​ following:   •   the​ investor's required rate of return is 14.5 ​percent, •   the expected level of earnings at the end of this year ​(E1​) is ​$6​, •   the retention ratio is 40 ​percent, •   the return on equity ​(ROE​) is 14 percent​ (that is, it can earn 14 percent on reinvested​ earnings), and •   similar shares of stock sell at multiples of 6.742 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?

Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
icon
Related questions
icon
Concept explainers
Topic Video
Question

Question content area top

Part 1
​(Common stock​ valuation)  Assume the​ following:
 
•  
the​ investor's required rate of return is
14.5
​percent,
•  
the expected level of earnings at the end of this year
​(E1​)
is
​$6​,
•  
the retention ratio is
40
​percent,
•  
the return on equity
​(ROE​)
is
14
percent​ (that is, it can earn
14
percent on reinvested​ earnings), and
•  
similar shares of stock sell at multiples of
6.742
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
80
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?
 
 
 

Question content area bottom

Part 1
a.  What is the expected growth rate for​ dividends?
 
enter your response here​%
​ (Round to two decimal​ places.)
Part 2
b.  What is the price earnings ratio
​(P​/E1​)?
 
enter your response here
​ (Round to three decimal​ places.)
Part 3
c.  What is the stock price using the ​P/E ratio valuation​ method?
 
​$enter your response here
​ (Round to the nearest​ cent.)
Part 4
d.  What is the stock price using the dividend discount​ model?
 
​$enter your response here
​ (Round to the nearest​ cent.)
Part 5
e.​ (i)  Using the dividend discount​ model, what would be the stock price if the company increased its retention rate to
80​%
​(holding all else​ constant)?
 
​$enter your response here  
​(Round to the nearest​ cent.)
Part 6
What would be the ​P/E ratio
​(P​/E1​)
if the company increased its retention ratio to
80​%
​(holding all else​ constant)?  
 
enter your response here  
​(Round to three decimal​ places.)
Part 7
e.​ (ii)  Using the dividend discount​ model, what would be stock price if the company paid out all its earnings in the form of​ dividends?
 
​$enter your response here  
​(Round to the nearest​ cent.)
Part 8
What would be the ​P/E ratio
​(P​/E1​)
and stock price if the company paid out all its earnings in the form of​ dividends?
 
enter your response here  
​(Round to three decimal​ places.)
Part 9
f.  What have you learned about the relationship between the retention ratio and the ​P/E​ ratio?  ​(Select from the​ drop-down menus.)
 
Assume that the​ investor's required rate of return is greater than the dividend growth​ rate, the higher the retention​ ratio, other things being the​ same, the
 
lower
higher
the value of the common stock and thus the
 
lower
higher
the price earnings​ ratio,
​P/E.
 
 
Expert Solution
trending now

Trending now

This is a popular solution!

steps

Step by step

Solved in 4 steps

Blurred answer
Knowledge Booster
Stock Valuation
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.
Similar questions
Recommended textbooks for you
Essentials Of Investments
Essentials Of Investments
Finance
ISBN:
9781260013924
Author:
Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:
Mcgraw-hill Education,
FUNDAMENTALS OF CORPORATE FINANCE
FUNDAMENTALS OF CORPORATE FINANCE
Finance
ISBN:
9781260013962
Author:
BREALEY
Publisher:
RENT MCG
Financial Management: Theory & Practice
Financial Management: Theory & Practice
Finance
ISBN:
9781337909730
Author:
Brigham
Publisher:
Cengage
Foundations Of Finance
Foundations Of Finance
Finance
ISBN:
9780134897264
Author:
KEOWN, Arthur J., Martin, John D., PETTY, J. William
Publisher:
Pearson,
Fundamentals of Financial Management (MindTap Cou…
Fundamentals of Financial Management (MindTap Cou…
Finance
ISBN:
9781337395250
Author:
Eugene F. Brigham, Joel F. Houston
Publisher:
Cengage Learning
Corporate Finance (The Mcgraw-hill/Irwin Series i…
Corporate Finance (The Mcgraw-hill/Irwin Series i…
Finance
ISBN:
9780077861759
Author:
Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Jeffrey Jaffe, Bradford D Jordan Professor
Publisher:
McGraw-Hill Education