honeycfa

An analyst gathered the following information about an industry. The industry beta is 0.9. The industry profit margin is 8%, the total asset turnover ratio is 1.5, and the leverage multiplier is 2. The dividend payout ratio of the industry is 50%. The risk-free rate is 7% and the expected market return is 15%. The industry P/E is closest to:

A) 22.73.

B) 12.00.

C) 14.20.

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Using the CAPM: k_i = 7% + 0.9(0.15 ? 0.07) = 14.2%.

Using the DuPont equation: ROE = 8% × 1.5 × 2 = 24%.

g = retention ratio × ROE = 0.50 × 24% = 12%.

P/E = 0.5/(0.142 ? 0.12) = 22.73.

honeycfa

A firm has an expected dividend payout ratio of 48 percent and an expected future growth rate of 8 percent. What should the firm's price to earnings ratio (P/E) be if the required rate of return on stocks of this type is 14 percent and what is the retention ratio of the firm?

       P/E ratio    Retention ratio

A) 6.5   52%

B) 8.0    52%

C) 6.5   48%

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P/E = (dividend payout ratio)/(k - g)

P/E = 0.48/(0.14 - 0.08) = 8

The retention ratio = (1 - dividend payout) = (1 - 0.48) = 52%

honeycfa

A firm has an expected dividend payout ratio of 50%, a required rate of return of 12% and a constant growth rate of 6%. If earnings for the next year are expected to be $4.50, the value of the stock today is closest to:

A) $39.75

B) $37.50

C) $33.50

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Expected dividend = $4.50 × 0.50 = $2.25

Value today = $2.25 / (0.12 - 0.06) = $37.50

honeycfa

According to the earnings multiplier model, a stock’s P/E ratio (P₀/E₁) is affected by all of the following EXCEPT the:

A) required return on equity.

B) expected stock price in one year.

C) expected dividend payout ratio.

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According to the earnings multiplier model, the P/E ratio is equal to P₀/E₁ = (D₁/E₁)/(k_e - g).

Thus, the P/E ratio is determined by:

• The expected dividend payout ratio (D₁/E₁).

• The required rate of return on the stock (k_e).

• The expected growth rate of dividends (g).

honeycfa

The earnings multiplier model, derived from the dividend discount model, expresses a stock’s P/E ratio (P₀/E₁) as the:

A) expected dividend payout ratio divided by the difference between the required return on equity and the expected dividend growth rate.

B) expected dividend payout ratio divided by the sum of the expected dividend growth rate and the required return on equity.

C) expected dividend in one year divided by the difference between the required return on equity and the expected dividend growth rate.

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Starting with the dividend discount model P₀ = D₁/(k_e - g), and dividing both sides by E₁ yields: P₀/E₁ = (D₁/E₁)/(k_e - g)

Thus, the P/E ratio is determined by:

• The expected dividend payout ratio (D₁/E₁).
• The required rate of return on the stock (k_e).
• The expected growth rate of dividends (g).>

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