Question

In: Finance

Consider the following scenario and complete the last column and then Assess the sensitivity of the...

Consider the following scenario and complete the last column and then Assess the sensitivity of the price-earnings ratio to changes in the cost of equity capital and changes in the growth rate:

Table 9

Estimating price earning(P/E) ratios under various scenarios

Scenario

Cost of Equity Capital

Growth Rate in Earnings

P/E Ratio

1

0.13

0.09

2

0.13

0.11

3

0.15

0.09

4

0.18

0.09

5

0.18

0.11

Solutions

Expert Solution

Payout ratio = 1- Growth rate Earning / Cost of Equity

Scenario Cost of Equity Growth Rate in Earning

Dividend Payout Ratio

=1- Growth earning/ Cost of Equity

P/E Ratio= Dividend Payout Ratio/ (Cost of Equity- Growth earning)
1 0.13 0.09

= 1- (0.09/0.13)

= 1- 0.69

=0.307

= 0.307/(0.13-0.09)

= 7.67x

2 0.13 0.11

=1-(0.11/0.13)

=1- 0.8461

= 0.1538

=0.1538/(0.13-0.11)

=7.69x

3 0.15 0.09

=1- (0.09/0.15)

=1-0.6

=0.4

=0.4/(0.15-0.09)

= 6.67x

4 0.18 0.09

=1-(0.09/0.18)

=1-0.5

= 0.5

=0.5/(0.18-0.09)

=5.56x

5 0.18 0.11

=1- (0.11/0.18)

=1-0.611

= 0.388

= 0.388/(0.18-0.11)

= 5.54x


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