Reference no: EM132588248

Common Stock Valuation

1. The investor's required rate of return of 13.5%,
2. The expected level of earnings at the end of this year (E1) is $6.00,
3. The retention ratio is 50%,
4. The return on equity (ROE) is 15% (that is, it can earn 15% on reinvested earnings), and

Similar shares of stock sell at multiples of 16.667 times earnings per share

Questions:

Question a. Determine the expected growth rate for dividends.

Question b. Determine the price earnings ratio (P/E1).

Question c. What is the stock price using the P/E ratio valuation method?

Question d. What is the stock price using the dividend discount model?

Question e. What would happen to the P/E ratio (P/E1) and stock price if the company increased its retention rate to 60% (holding all else constant)? What would happen to the P/E ratio (P/E1) and stock price if the company paid out all its earnings in the form of dividends?

Question f. What have you learned about the relationship between the retention rate and P/E ratios?