LOS g: Calculate the justified leading and trailing P/Es based on fundamentals using the Gordon growth model.

Q1. If an asset’s beta is 0.8, the expected return on the equity market is 10.0%, and the appropriate discount rate for the Gordon model is 9.0%, what is the risk-free rate?

A)   5.00%.

B)   6.50%.

C)   2.50%.

Q2. Stan Bellton, CFA, is preparing a report on TWR, Inc. Bellton’s supervisor has requested that Bellton include a justified trailing price-to-earnings (P/E) ratio based on the following information:

Current earnings per share (EPS) = $3.50.
Dividend Payout Ratio = 0.60.
Required return for TRW = 0.15.
Expected constant growth rate for dividends = 0.05.

TWR’s justified trailing P/E ratio is closest to:

A)   4.0.

B)   6.0.

C)   6.3.

Q3. A firm has the following characteristics:

• Current share price $100.00.
• Next year's earnings $3.50.
• Next year's dividend $0.75.
• Growth rate 11%.
• Required return 13%.

Based on this information and the Gordon growth model, what is the firm’s justified leading price to earnings (P/E) ratio?

A)   10.7.

B)   11.3.

C)   8.7.

Q4. A firm has the following characteristics:

• Current share price $100.00.
• One-year earnings $3.50.
• One-year dividend $0.75.
• Required return 13%.
• Justified leading price to earnings 10.

Based on the dividend discount model, what is the firm’s assumed growth rate?

A)   10.9%.

B)   12.4%.

C)   8.6%.

Q5. A firm has the following characteristics:

• Current share price $100.00.
• Current earnings $3.50.
• Current dividend $0.75.
• Growth rate 11%.
• Required return 13%.

Based on this information and the Gordon growth model, what is the firm’s justified trailing price to earnings (P/E) ratio?

A)   8.9.

B)   11.9.

C)   11.3.

LOS g: Calculate the justified leading and trailing P/Es based on fundamentals using the Gordon growth model. fficeffice" />

Q1. If an asset’s beta is 0.8, the expected return on the equity market is 10.0%, and the appropriate discount rate for the Gordon model is 9.0%, what is the risk-free rate?

A)   5.00%.

B)   6.50%.

C)   2.50%.

Correct answer is A)

Required return = risk-free rate + beta (expected equity market return – risk-free rate)
9% = risk-free rate + 0.8(0.10 – risk-free rate)
9% = 0.08 + 0.2(risk-free rate)
1% / 0.2 = risk-free rate = 0.05 or 5%

Q2. Stan Bellton, CFA, is preparing a report on TWR, Inc. Bellton’s supervisor has requested that Bellton include a justified trailing price-to-earnings (P/E) ratio based on the following information:

Current earnings per share (EPS) = $3.50.
Dividend Payout Ratio = 0.60.
Required return for TRW = 0.15.
Expected constant growth rate for dividends = 0.05.

TWR’s justified trailing P/E ratio is closest to:

A)   4.0.

B)   6.0.

C)   6.3.

Correct answer is C)

The dividend payout ratio (1 – b) is 0.60, so the retention ratio (b) is 0.4.

Q3. A firm has the following characteristics:

• Current share price $100.00.
• Next year's earnings $3.50.
• Next year's dividend $0.75.
• Growth rate 11%.
• Required return 13%.

Based on this information and the Gordon growth model, what is the firm’s justified leading price to earnings (P/E) ratio?

A)   10.7.

B)   11.3.

C)   8.7.

Correct answer is A)

The justified leading P/E is 10.7:

P₀ / E₁ = ($0.75 / $3.50) / (0.13 – 0.11) = 10.714

Q4. A firm has the following characteristics:

• Current share price $100.00.
• One-year earnings $3.50.
• One-year dividend $0.75.
• Required return 13%.
• Justified leading price to earnings 10.

Based on the dividend discount model, what is the firm’s assumed growth rate?

A)   10.9%.

B)   12.4%.

C)   8.6%.

Correct answer is A)

The assumed growth rate is 10.9%:

P₀ / E₁ = ($0.75/$3.50) / (0.13 – g) = 10, g = 10.86%

Q5. A firm has the following characteristics:

• Current share price $100.00.
• Current earnings $3.50.
• Current dividend $0.75.
• Growth rate 11%.
• Required return 13%.

Based on this information and the Gordon growth model, what is the firm’s justified trailing price to earnings (P/E) ratio?

A)   8.9.

B)   11.9.

C)   11.3.

Correct answer is B)

The justified trailing P/E is 11.9:

P₀ / E₀ = [($0.75)(1 + 0.11)/$3.50] / (0.13 – 0.11) = 11.8929

thanks a lot