Question

Deakin Ltd has just recently published following financial information:

Expected earnings per share $20

Deakin’s market beta 0.8

Earnings per share to be retained by the firm 30%

Growth rate in earnings per share 7% p.a.

Required:

1. Calculate Deakin's P/E ratio if the expected return on the ASX300 is 12% p.a. and the return on 10 year Commonwealth Government Bonds is 4% p.a. What does this ratio tell you?

2. Calculate Deakin's share price using P/E ratio calculated in Part 1.

Answer 1

	Deakin Ltd
	Expected EPS =$20
	Expected Retaining Ratio=R=30%
	Expcted Dividend payout =70%
	Expected Dividend =D1=20*70%= $14
	EPS growth rate =g=7% pa
	Market beta =0.8
	Risk free rate =Rf=4%
	Expected Market return =Rm=12%
	Assume cost of Equity =k
	as per CAPM ;
	k=Rf+beta*(Rm-Rf)
	k=4%+0.8*(12%-4%)
	k=10.4%
	So cost of Equity =k=10.4%
	Now, by Dividend Growth Model;
	Price of Share P0=D1/(k-g)=14/(10.4%-7%)
	P0=411.76
	So Current share prie=$411.76
Ans 1.	P/E ratio= Share Price/EPS=$411.76/$20=	20.588
	As the P/E ratio is quite high, it indicates that the investors
	are willing to pay a higher price in comparison of EPS as
	investors are expecting a high growth rate from the company
	in future.
	Ans 2.
	P/E ratio =20.588
	EPS=$20
	So Price per share =20*20.588=$411.76