Equity Investments - Equity Investments Section 2
88. An investor gathers the following data:
| ROE | 15% |
| Retention Ratio | 70% |
| Required Return on Shares | 12% |
| Next Year’s EPS | $5 |
The justified forward P/E is closest to:
- Option : B
- Explanation : Growth = Retention Ratio * ROE = 0.7 * 0.15 = 0.105 Justified Forward PE = Payout Ratio / (r - g) = (1 - 0.7) / (0.12 - 0.105) = 20
| Company | Gamma | Theta |
| Return on equity | 15.00% | 13.50% |
| Payout ratio | 45.00% | 50.00% |
The required rate of return is 11%. If Gamma’s payout ratio increases to 55% and Theta’s payout ratio decreases to 40%, what would be the most likely resultant effect on their justified P/E ratios?
- Option : C
- Explanation : To find the intrinsic value of the stock today, we would take the present value of D1, D2, D3 and P3.
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