In: Finance
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 |
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 |