Question

Devs Inc. is currently trading at a forward P/D (price-to-dividend) ratio of 25, a forward P/E ratio of 20, a P/B ratio of 4 and a P/S ratio of 3. Please answer the following questions:

(a) What is Devs Inc.'s PEG ratio (PE divided by g expressed in %) equal to?

(b) What is Devs Inc.'s net prot margin (NPM) equal to?

(c) What is Devs Inc.'s required rate of return (r_e) equal to?

Answer 1

Given about Devs Inc.,

Forward P/D ratio = P0/D1 = 25

Forward P/E ratio P0/E1 = 20

P/B ratio = P0/equity = 4

P/S ratio = P0/sales = 3

a). So, Firms Return on equity, ROE = Net income/equity = E/B = (P/B)/(P/E) = 4/20 = 20%

Dividend payout ratio = D1/E1 = (P/E1)/(P/D1) = 20/25 = 80%

So, firms growth rate = ROE*(1-Payout ratio) = 0.2*(1-0.2) = 0.04 or 4%

So, Firm PEG ratio = (P/E1)/g = 20/4 = 5

b). Net profit margin = Net income/Sales = (P/sales)/(P/E1) = 3/20 = 15%

c). Required rate of return can be calculated using constant dividend growth model:

Required rate of return re = D1/P + g = 1/25 + 0.04 = 8%