(relative valuation of common stock) Using the P/E ratio approach to valuation,

Question

(relative valuation of common stock) Using the P/E ratio approach to valuation, calcualte the value of a share of stockunder the following conditions:
the investor's require rate of return is 12 percent
the expected level of earnings at the end of this year (e) is $6
the firm follows a policy of retarining 60 percent of its earnings
the return on equity (ROE) is 14 percent and
similar shares of stock sell at mltiples of 11.112 times earnngs per share
Now show that you get the same answer using the idcounted dividend model
a. The stock price using the p/e ration valuation method is $?
b. The stock price using the dividend discount model is $?

Explanation / Answer

a) p/e ration valuation Market Value per Share / Earnings per Share earnings 6 similar share PE 11.112 times Stock price per share 66.672 (6*11.112) b) Dividend discount model EPS 6 Payout (1-retaining)= 40% Dvidend per share 2.4 (6*.4) Market value= Dividend per share/(return on equity-expected return) 120 (2.4/(14%-12%))

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