10-14 (Valuing Common Stock) Assume the following: The investor's required rate of return is 15 percent. The expected level of earnings at the end of this year (E1) is $5.00. The retention ratio is 50 percent. The return on equity (ROE) is 20 percent (that is, it can earn 20 percent on reinvested earnings). Similar shares of stock sell at multiples of 10 times earnings per share.

a. Determine the expected growth rate for dividends. b. Determine the price/earnings ratio (P/E1) using Equation (10-5a) see below 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 (PIE p) and stock price if the firm could earn 25 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 the P/E ratio?

10-5. (Valuing common stock) The common stock of CP paid $1.32 in dividends last year. Dividends are expected to grow at an 8 percent annual rate for an indefinite number of years. a. If your required rate of return is 10.5 percent, what is the value of the stock to you? b. Should you make the investment?