Question

TSM currently has 0.3 payout ratio for dividends. The company has ROE of 15% and required return of 12%. If the company increase the payout ratio to 0.4, how much will the forward P/E ratio change?

Answer 1

First of all lets find growth rate

here payout ratio = 0.3

hence retention ratio = 1-0.3 = 0.7

Growth rate = ROE x Retention ratio

=15% x 0.7

=10.5%

Forward PE ratio = Payout ratio/(Required return - Growth rate)

=0.3/(12%-10.5%)

=0.3/1.5%

=20

Now if payout ratio is increased to 0.4, then

hence retention ratio = 1-0.4 = 0.6

Growth rate = ROE x Retention ratio

=15% x 0.6

=9%

Forward PE ratio = Payout ratio/(Required return - Growth rate)

=0.4/(12%-9%)

=0.4/3%

=13.33

Thus Forward PE ratio will change by 20 -13.33 = 6.67