the investor's required rate of return is 12.5 percent, bullet the expected level of earnings at the end of this year (Upper E 1 ) is $14 , bullet the retention ratio is 30 percent, bullet the return on equity (ROE) is 13 percent (that is, it can earn 13 percent on reinvested earnings), and bullet similar shares of stock sell at multiples of 8.139 times earnings per share. Questions:

a.Determine the expected growth rate for dividends.

b.Determine the price earnings ratio (P/Upper E 1 ).

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/Upper E 1 ) and stock price if the company increased its retention rate to 70 percent (holding all else constant)? What would happen to the P/E ratio (P/Upper E 1 ) and stock price if the company paid out all its earnings in the form of dividends?

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