(Common stockvaluation)Assume thefollowing:

theinvestor's required rate of return is 13.5 percent,

the expected level of earnings at the end of this year (E1) is $8,

the retention ratio is 45 percent,

the return on equity (ROE) is 15 percent(that is, it can earn 15 percent on reinvestedearnings), and

similar shares of stock sell at multiples of 8.149 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 valuationmethod?

d.What is the stock price using the dividend discountmodel?

e.What would happen to the P/E ratio (P/E1) and stock price if the company increased its retention rate to 60 percent(holding all elseconstant)? What would happen to the P/E ratio (P/E1) and stock price if the company paid out all its earnings in the form ofdividends?

f.What have you learned about the relationship between the retention rate and the P/Eratios?