2.( Common stock valuation) assume the following:
- The investors required rate of return is 12.5
- The expected level of earnings at the end of this year (E1) is $8.
- The retention ratio is 35 percent
- The return on equity (ROE)is 13 percent ( that is, it can earn 13 percent on reinvested earnings) and
- Similar shares of stock sell at multiples of 8.176 times earnings per share.
a. What is the expected growth rate for dividends?
b. What is the price earnings ratio?
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. Using the dividend discount model, what would be the stock price if the company increased its retention rate to 60% (holding all else constant)?
What would be the P/E ratio (P/E1) if the company increased its retention ratio to 60% (holding all else constant)?(round to three decimal places)
e. (ii) Using the dividend discount model, what would be stock price if the company paid out all its earnings in the form of dividends?(round to the nearest cent.)
What would be the P/E ratio, (P/E1) and the stock price if the company paid out all it's earning in the form of dividends? Round to three decimal places
f. What have you learned about the relationship between the retention ratio and the P/E ratio? Assume that the investor's required rate of return is greater than the dividend growth rate, the higher the retention ratio, other things being the same the lower or higher the value of the common stock and thus the lower or higher the price earnings ratio, P/E.
(Select one)
Assume that the investor's required rate of return is greater than the dividend growth rate, the higher the retention ratio, other things being the same, the (lower or higher)the value of the common stock and thus the (lower or higher) the price earning ratio P/E.