Answered step by step
Verified Expert Solution
Link Copied!

Question

1 Approved Answer

Consider a firm that is expected to earn $5 per share next year. EPS will continue at this level in perpetuity assuming none of the

Consider a firm that is expected to earn $5 per share next year. EPS will continue at this level in perpetuity assuming none of the earnings are reinvested.

a. Suppose, at the end of each of the next five years the firm can reinvest $3 per share and those funds will earn a level 20% annual return in perpetuity starting the year after being reinvested. What is the price per share and P/E ratio if investors require a 12% return on investment?

b. Show that the P/E ratio is the reciprocal of the interest rate (investors required rate of return) if the reinvestment rate falls from 20% to 12%.

c. What is the relation between the P/E ratio and investors required rate of return when the latter is greater, smaller, or equal to the firms reinvestment rate of return?

Step by Step Solution

There are 3 Steps involved in it

Step: 1

blur-text-image

Get Instant Access to Expert-Tailored Solutions

See step-by-step solutions with expert insights and AI powered tools for academic success

Step: 2

blur-text-image

Step: 3

blur-text-image

Ace Your Homework with AI

Get the answers you need in no time with our AI-driven, step-by-step assistance

Get Started

Recommended Textbook for

Finance And Financial Markets

Authors: Keith Pilbeam

3rd Edition

023023321X, 978-0230233218

More Books

Students also viewed these Finance questions

Question

4. Choose appropriate and powerful language

Answered: 1 week ago

Question

2. Choose an appropriate organizational pattern for your speech

Answered: 1 week ago