A firm has a stock price of $50 per share. The firm’s past 12 month earnings per
ID: 2738645 • Letter: A
Question
A firm has a stock price of $50 per share. The firm’s past 12 month earnings per share is $2.5 and the firm's future earning is $5 per share. The firm has an ROE of 20% and a dividend payout ratio of 50%. Given an industry average PEG ratio of 1.6, is the firm’s stock more likely to be overpriced or underpriced?
Underpriced, because it has a PEG ratio of 1
Overpriced, because it has PEG ratio of 1
Overpriced, because it has PEG ratio of 2
Underpriced, because it has a PEG ratio of 2
A.Underpriced, because it has a PEG ratio of 1
B.Overpriced, because it has PEG ratio of 1
C.Overpriced, because it has PEG ratio of 2
D.Underpriced, because it has a PEG ratio of 2
Explanation / Answer
Growth Rate = Retention ratio * ROE
g = b * r
g = 0.50 * 0.20
g = 0.10 i.e. 10%
PEG Ratio = (Price / Earnings) / EPS Growth Rate
= (50/5) / 10
= 1
Answer is
A.
Underpriced, because it has a PEG ratio of 1
Underpriced, because it has a PEG ratio of 1
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