Question

A firm has earnings of $1.45 this year and a P/E ratio of 20. It is...

A firm has earnings of $1.45 this year and a P/E ratio of 20. It is currently expected to grow at 3.6% per year forever. What would its new P/E ratio be if it could increase this growth to 5.7% per year without a change in its cost of capital?

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Answer #1

PE Ratio = 20

Price / Earnings = 20

Price = 20 * Earnings

= 20 * 1.45

= 29

D0 = 1.45

Value of Stock =

29   =

29 * Rate of Return - 29 * 0.036 = 1.5022

29 * Rate of Return - 1.044 = 1.5022

Rate of Return = (1.5022 + 1.044) / 29

Rate of Return = 8.78%

Price at new Growth Rate =

=

= 1.53265 / 0.0308

= 49.76

NEW PE = Price / Earning

= 49.76 / 1.45

= 34.32

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