70.2K

Verified Solution

Link Copied!

Assume the following: the investor's required rate of return is 14 percent, the expected level of earnings at the end of this year (E1) is $10, the retention ratio is 30 percent, the return on equity (ROE) is 12 percent (that is, it can earn 12 percent on reinvested earnings), and similar shares of stock sell at multiples of 6.731 times earnings per share. Questions: a.Determine the expected growth rate for dividends. b.Determine the price earnings ratio (P/E1). c.What is the stock price using the P/E ratio valuation method? d.What is the stock price using the dividend discount model? e.What would happen to the P/E ratio (P/E1) and stock price if the company increased its retention rate to 80 percent (holding all else constant)? What would happen to the P/E ratio (P/E1) and stock price if the company paid out all its earnings in the form of dividends? f.What have you learned about the relationship between the retention rate and the P/E ratios? Question content area bottom Part 1 a.What is the expected growth rate for dividends? % (Round to two decimal places.) Part 2 b.What is the price earnings ratio (P/E1)? (Round to three decimal places.) Part 3 c.What is the stock price using the P/E ratio valuation method? $ (Round to the nearest cent.) Part 4

d.What is the stock price using the dividend discount model? $ (Round to the nearest cent.) Part 5 e. Using the dividend discount model, what would be the stock price if the company increased its retention rate to 80% (holding all else constant)? $(Round to the nearest cent.) Part 6 What would be the P/E ratio (P/E1) if the company increased its retention ratio to 80% (holding all else constant)? (Round to three decimal places.) Part 7 e. Using the dividend discount model, what would be stock price if the company paid out all its earnings in the form of dividends? $ (Round to the nearest cent.) Part 8 What would be the P/E ratio (P/E1) and stock price if the company paid out all its earnings in the form of dividends? (Round to three decimal places.) Part 9 f.What have you learned about the relationship between the retention ratio and the P/E ratio?(Select from the drop-down menus.) Assume that the investor's required rate of return is greater than the dividend growth rate, the higher the retention ratio, other things being the same, the lower/higher the value of the common stock and thus the lower/higher the price earnings ratio, P/E.

Answer & Explanation Solved by verified expert

See Answer