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firm projects an ROE of 12.5%, and it will maintain a dividend payout ratio of 0.6....

firm projects an ROE of 12.5%, and it will maintain a dividend payout ratio of 0.6. Its earning this year will be $2 per share. Investors expect a 12% rate of return on the security. At what price and P/E ratio would you expect the firm to sell?

1.

x 5.57
2.

x 6.57
3.

x 7.57
4.

x 8.57
5.

x 9.57
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Answer #1
Return on equity (ROE) 12.50%
Dividend payout ratio 60%
Retention ratio=1-payout ratio 40%
Growth rate=Retention * ROE 5.00%
Next EPS $         2.00
Dividend payout ratio 60%
Next dividend= 2*60%
Current Dividend $         1.20
Required return 12.00%
Growth Rate 5.00%
Share price =Next Dividend*(1+Growth rate)/(Rate of return-Growth Rate)
Share price =1.2/(0.12-0.05)
Share price $       17.14
PE ratio= Share price/EPS 17.14/2
PE ratio= Share price/EPS 8.57
Hence option 4 is the correct solution.
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