Question

The market capitalization rate on the stock of Aberdeen Wholesale Company is 13%. Its expected ROE is 15%, and its expected EPS is $6. If the firm's plowback ratio is 70%, its P/E ratio will be _________.

Multiple Choice

• 9.23

• 12.00

• 25.73

• 40.00

Answer 1

Solution:

Market capitalization rate: 13%, Expected ROE: 15%, Expected EPS: $6. Plowback ratio is 70%

We Know that; Dividend Payout Ratio = 1 - Plowback ratio = 1 - 0.70 = 0.30 or 30%

Expected Dividend = Expected EPS * Dividend Payout ratio = $ 6 * 0.30 = $ 1.80

Growth Rate = Plowback Ratio * ROE = 0.15 * 0.70 = 0.105 or 10.5%

Price of the Share: Expected Dividend / (Capitalization Rate - Growth Rate)

Price of the Share: $ 6 / (0.13 - 0.105) = $ 240

So the P/E ratio will be : Price per share / Earning per share

P/E ratio will be : 240 / 6 = 40 times

Note: Plowback ratio is also called "Retention Ratio".

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