Using the P/E ratio approach to valuation, calculate the value of a share of sto

ID: 2650787 • Letter: U

Question

Using the P/E ratio approach to valuation, calculate the value of a share of stock under the following conditions:

- the investors required rate of return 13%

-the expected level of earning at the end of the year (E1) is $6

-the firm follows a policy of retaining 50% of it's earnings.

-the return on equity (ROE) is 16%, and

-similar shares of stock sell at multiples of 10.000 times earning per share.

now show that you get the same answer using the discounted dividend model.

a. the stock price using the P/E ratio valuation method is $________ (round to the nearest cent.)

b. The stock price using the dividend discount model is $_________ (round to the nearest cent.)

a. the stock price using the P/E ratio valuation method is $________ (round to the nearest cent.)

P/E ratio =10

EPS = 6

Stock price = EPS*P/E ratio

Stock price = 6*10

Stock price = $ 60

b. The stock price using the dividend discount model is $_________ (round to the nearest cent.)

Payout ratio = (1-retention ratio)

Payout ratio = (1-50%)

Payout ratio = 50%

Expected Dividend per Share (D1) = EPS*Payout ratio

Expected Dividend per Share (D1) = 6*50%

Expected Dividend per Share (D1) = $ 3

Growth Rate = ROE*retention ratio

Growth Rate = 16%*50%

Growth Rate = 8%

Required Rate of return = 13%

Stock price = Expected Dividend per Share (D1) /(Required Rate of return - Growth Rate)

Stock price = 3/(13%-8%)

Stock price = $ 60

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