Question

Lee Sports projects an ROE of 20%, and it will maintain a plowback ratio of 0.3. its earnings this year will be $2/share. Investors expect a 12% rate of return on the stock.

a) What is the price and P/E ratio?

b) What is the PVGO?

Answer 1

a. The price is computed as follows:

= [ EPS x (1 - plowback ratio) ] / (expected return - (ROE x plowback ratio)

= [ $ 2 x (1 - 0.30) ] / (0.12 - (0.20 x 0.30) )

= $ 1.4 / 0.06

= $ 23.333333 or $ 23.33 Approximately

PE is computed as follows:

= Price computed above / Earnings per share

= $ 23.333333 / $ 2

= 11.67 times Approximately

b. PVGO is computed as follows:

g is computed as follows:

= plowback ratio x ROE

= 0.30 x 0.20

= 0.06

So, the PVGO will be as follows:

= [ Earnings x (1 - plowback ratio) / (rate of return - growth rate) ] - Earnings / rate of return

= [ $ 2 x (1 - 0.30) / (0.12 - 0.06) ] - $ 2 / 0.12

= $ 1.4 / 0.06 - $ 2 / 0.12

= $ 6.67 Approximately

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