Equity Investments MCQ - 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:
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
89
Two companies, Gamma and Theta have justified forward P/E ratios of 12.59x and 14.29x respectively. Their ROE and payout ratios are:
| 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?
To find the intrinsic value of the stock today, we would take the present
value of D1, D2, D3 and P3.
