(Common stock valuation) Assume the following: bullet the investor’s required rate of return is 14 percent, bullet the expected level of earnings at the end of this year (Upper E 1) is $8, bullet the retention ratio is 50 percent, bullet the return on equity (ROE) is 16 percent (that is, it can earn 16 percent on reinvested earnings), and bullet similar shares of stock sell at multiples of 8.334 times earnings per share. Questions:
a. Determine the expected growth rate for dividends.
b. Determine the price earnings ratio (P/Upper E 1).
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. What would happen to the P/E ratio (P/Upper E 1) and stock price if the firm could earn 21 percent on reinvested earnings (ROE)?
f. What does this tell you about the relationship between the rate the firm can earn on reinvested earnings and P/E ratios?Get Finance homework help today