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(Common stock valuation) Assume the following: - the investor's required rate of return is 17 percent, - the expected level of earnings at the end
(Common stock valuation) Assume the following: - the investor's required rate of return is 17 percent, - the expected level of earnings at the end of this year (E1) is $6, - the retention ratio is 45 percent, - the return on equity (ROE) is 18 percent (that is, it can earn 18 percent on reinvested earnings), and - similar shares of stock sell at multiples of 6.180 times earnings per share. Questions: a. Determine the expected growth rate for dividends. b. Determine the price earnings ratio (P/E1). 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/E1) and stock price if the firm could earn 23 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
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