Question
In: Finance
(Common stock valuation) Assume the following: bullet the investor's required rate of return is 14 percent,...
(Common stock valuation) Assume the following: bullet the investor's required rate of return is 14 percent, bullet the expected level of earnings at the end of this year (Upper E 1) is $6, bullet the retention ratio is 40 percent, bullet the return on equity (ROE) is 16 percent (that is, it can earn 16 percent on reinvested earnings), and bullet similar shares of stock sell at multiples of 7.895 times earnings per share. Questions: a. Determine the expected growth rate for dividends. b. Determine the price earnings ratio (P/Upper E 1). 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/Upper E 1) and stock price if the firm could earn 21 percent on reinvested earnings (ROE)? f. What does this tell you about the relationship between the rate the firm can earn on reinvested earnings and P/E ratios?
Solutions
Expert Solution
| Given | |
| Required Rate of Return (Ke) | 14% |
| Upper E 1 | $6 |
| Retention Ratio | 40% |
| RoE% | 16% |
| PE multiple of similar stock | 7.895 |
| Calculated | |
| Expected Dividend (D1) | $3.60 |
| (1-Retention Ratio)* Upper E 1 | ((1-40%)*6) |
| Expected growth rate for dividends (g) | 6.4% |
| (Retention Ratio*RoE%) | (40%*16%) |
| Determine Price earnings ratio (P/Upper E 1) | 7.89 |
| (D1/(Ke-g))/Upper E1 | (3.6/(14%-6.4%))/6 |
| Stock price using the P/E ratio valuation method | $47.37 |
| (PE of comparable * Upper E 1) | (7.895*6) |
| Stock price using the dividend discount model | $47.37 |
| D1/(Ke-g) | 3.6/(14%-6.4%) |
| What would happen to the P/E ratio (P/Upper E 1) and stock price if the firm could earn 21 percent on reinvested earnings (ROE) | |
| Revised Expected growth rate for dividends (g) | 8.4% |
| (Retention Ratio*RoE%) | (40%*21%) |
| Revised Stock price using the dividend discount model | 64.29 |
| D1/(Ke-g) | 3.6/(14%-8.4%) |
| Revised Price earnings ratio (P/Upper E 1) | 10.714 |
| (D1/(Ke-g))/Upper E1 | (3.6/(14%-8.4%))/6 |
| There is a positive relation ship between the ROE and the PE ratio. As higher Roe increased the future growth rate which ultimately increase the stock intrinsic value which led to increase in the stock PE ratio | |
jeff jeffy answered 1 year agoRelated Solutions
Assume the following: • the investor's required rate of return is 18 percent, • the expected...
Assume the following:
• the investor's required rate of return is 18 percent,
• the expected level of earnings at the end of this year
(E1) is $9,
• the retention ratio is 55 percent,
• the return on equity (ROE) is 19 percent (that is, it can
earn 19 percent on reinvested earnings), and
• similar shares of stock sell at multiples of 5.960 times
earnings per share.
QUESTIONS:
a. What is the expected growth rate for dividends? (?)%...
NEED ANSWERS TO (e) and (f ) only: (Common stock valuation) Assume the following: the investor's...
NEED ANSWERS TO (e) and (f ) only:
(Common stock valuation) Assume the following:
the investor's required rate of return is 13.5percent,
the expected level of earnings at the end of this year (E1) is
$8
the retention ratio is 45 percent,
the return on equity (ROE) is 15 percent (that is, it can
earn 15 percent on reinvested earnings), and similar shares of
stock sell at multiples of 8.149 times earnings per share.
Questions:
a. Determine the expected growth...
Assume the following: • the investor's required rate of return is 15 percent, • the expected level of earnings at the end of this year (E1) is $5
Assume the following:• the investor's required rate of return is 15 percent,• the expected level of earnings at the end of this year (E1) is $5• the retention ratio is 50 percent,• the return on equity (ROE) is 20 percent? (that is, it can earn 20 percent on reinvested earnings), and• similar shares of stock sell at multiples of 10.000 times earnings per share.
Questions:a. Determine the expected growth rate for dividends.b. Determine the price earnings ratio (P/E1).c. What is...
An investor with a required return of 14 percent for very risky investments in common stock...
An investor with a required return of 14 percent for very risky
investments in common stock has analyzed three firms and must
decide which, if any, to purchase.
The information is as follows: Firm A B C Current earnings $
1.60 $ 3.50 $ 6.70 Current dividend $ 1.40 $ 4.40 $ 5.90 Expected
annual growth rate in 6 % 3 % -3 % dividends and earnings Current
market price $ 24 $ 46 $ 37
What is the maximum...
Assume that your required rate of return is eight percent and you are given the following...
Assume that your required rate of return is eight percent and
you are given the following stream of cash flows: Year Cash Flow 1
$434 2 $696 3 $767 4 $646 5 $862 6 $397 If payments are made at the
end of each period, what is the present value of the cash flow
stream? Select one: a. $2,809.88 b. $2,668.92 c. $42,344.29 d.
$34,434.92 e. $2,919.10
For a bond of a given par value, the higher the investor's required rate of return...
For a bond of a given par value, the higher the investor's
required rate of return is above the coupon rate, the
The stock of Business Adventures sells for $80 a share. Its
likely dividend payout and end-of-year price depend on the state of
the economy by the end of the year as follows:
Stock Price
Dividend
Recession
$76
$0.75
Normal economy
82
2.50
Boom
87
3.00
Calculate the expected return and standard deviation of a...
1. How is an investor's required return rate of return related to an opportunity cost? 2....
1. How is an investor's required return rate of return related
to an opportunity cost?
2. How do flotation costs impact the firm's cost of capital?
4) Assume that your required rate of return is 12 percent and you are given the following...
4) Assume that your required rate of return is
12 percent and you are given the following stream of cash
flows:
Year Cash
Flow
0 $10,000
1 $15,000
2 $15,000
3 $15,000
4 $15,000
5 $20,000
If payments are made at the end of each period, what is the
present value of the cash flow stream?
A. $66,909
B. $57,323
C. $61,815
D. $52,345
show how to calculate it by financial calculator
Constant Growth Stock Valuation Investors require a 14% rate of return on Brooks Sisters' stock (rs...
Constant Growth Stock Valuation
Investors require a 14% rate of return on Brooks Sisters' stock
(rs = 14%).
What would the estimated value of Brooks' stock be if the
previous dividend was D0 = $1.75 and if investors expect
dividends to grow at a constant annual rate of (1) - 6%, (2) 0%,
(3) 5%, or (4) 10%? Do not round intermediate calculations. Round
your answers to the nearest cent.
$
$
$
$
Using data from Part a, what...
BETA AND REQUIRED RATE OF RETURN a. A stock has a required return of 9%; the...
BETA AND REQUIRED RATE OF RETURN
a. A stock has a required return of 9%; the risk-free rate is
5%; and the market risk premium is 3%. What is the stock's beta?
Round your answer to two decimal places.
b. If the market risk premium increased to 10%, what would
happen to the stock's required rate of return? Assume that the
risk-free rate and the beta remain unchanged. If the stock's beta
is equal to 1.0, then the change in...
ADVERTISEMENT
ADVERTISEMENT
Latest Questions
- You have invested 30 percent of your portfolio in Jacob, Inc., 40 percent is Bella Co.,...
- Parallel Arrays This question is in MindTap Cengage Summary In this lab, you use what you...
- 5. You have invested 30 percent of your portfolio in Jacob, Inc., 40 percent is Bella...
- JAVA Write a test program that prompts the user to enter a series of integers and...
- (2) Cite an example on how organizations like Google, Facebook, Youtube etc collect data for image...
- The legal landscape is perpetually changing. Psychologists must remain abreast of these changes to avoid potentially...
- We are evaluating a project that costs $1.68 million, has a six-year life, and has no...
ADVERTISEMENT