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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