Please help me with FRA questions expected, increase, investor, required, please

orang3eph

I cannot solve these questions, please help me!

1. Baker Computer earned $6.00 per share last year, has a retention ratio of 55%, and ROE is 20%. Assuming their required rate of return is 15%, how much would an investor pay for Baker on the basis of the earnings multiplier model?

2. If the expected dividend payout ratio of a firm is expected to rise from 50% to 55%, the cost of equity is expected to increase from 10% to 11%, ad the firm's growth rate remains at 5%, what will happen to the firm's P/E ratio? (unchange, increase or decline)

I really appreciate your helps. Thanks.

Valores

2)

Since the expected dividend ratio is increasing by 10% [(55-50)/50] and the cost of equity is increasing by 10% [(11-10)/10] and there is no change in the firm's growth rate; the P/E ratio should remain unchanged.

PS: These are the topics of Equity not FRA I guess....



Edited 1 time(s). Last edit at Monday, August 22, 2011 at 06:51AM by mohammad.belaal.

morebeans

1)

k = Cost of Capital = 15%
g = Sustainable Growth Rate = ROE x Retention Rate = 20% * 0.55 = 11%
EPS = $6
D0 = EPS x Dividend Payout Ratio = 6 * 0.45 = $2.7
D1 = Next year's Dividend = D0*(1+g) = 2.7*(1+0.11) = $2.997
P0 = Current Year's Price = D1/(k-g)
P0 = 2.997 / (0.15-0.11)
P0 = 2.997/0.04
P0 = $74.925


Based upon Dividend Discount Motel with Sustainable Growth.

yuoska

Thanks for your helps.

I found these questions but I don't really know exactly source. Maybe they related to Equity and Corporate Finance more than FRA

Can you explain me more about question 2?
Both divident payout ratio and cost of equite rise by percentage...

morebeans

And in 1st question I used ''k' as cost of capital. It's basically cost of equity. Capital also includes debt.

OmarAdnan

Thanks so much for your specific explanation.