Question

A company reinvests 60 percent of its earnings in the firm. Next year’s dividend is projected to be $2.50 per share. The discount rate is 15 percent and the grown rate is 10 percent. What is the price-earnings ratio?

A) 6.7

B) 8.0

C) 12.0

D) 16.7

E) 20.0

Answer 1

Answer:
Required Return = 15%
Expected Dividend = $2.50
Growth Rate = 10%

Required Return = Expected Dividend / Current Price + Growth Rate
0.15 = $2.50 / Current Price + 0.10
0.05 = $2.50 / Current Price
Current Price = $50

Retention Ratio = 60%
Dividend Payout Ratio = 1 – Retention Ratio
Dividend Payout Ratio = 1 – 0.60 = 0.40 or 40%

Dividend Payout Ratio = Dividend Paid / Earnings per Share
0.40 = $2.50 / Earnings per Share
Earnings per Share = $6.25

Price- earnings ratio = Price per share / Earnings per Share
Price- earnings ratio = $50 / $6.25
Price- earnings ratio = 8.0

Option B is Correct.