(Ordinary share valuation) Assume the following: the investors required rate of return is 15% the expected level of earnings at the end of this year (E|) is $5.00 the retention ratio is 50% the return on equity (ROE) is 20% (i.e. it can earn 20% on reinvested earnings) similar shares sell at multiples of 10 times earnings per share.

Questions:

(a) Determine the expected growth rate for dividends.

(b) Determine the price/earnings ratio (P!E\) using equation.

(c) What is the share price using the P/E ratio valuation method?

(d) What is the share price using the dividend discount model?

(e) What would happen to the P/E ratio (P!E\) and share price if the firm could earn 25% 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?

Using the correct formulas, not excel calculators/cells