Question

The market capitalization rate on the stock of Aberdeen Wholesale Company is 14%. Its expected ROE is 15%, and its expected EPS is $6. If the firm's plowback ratio is 60%, its P/E ratio will be _________.

Answer 1

Answer:

8

Explanation:

Data provided in the question:

The market capitalization rate on the stock = 14%

Expected ROE = 15%

Expected EPS = $56

Firm's plowback ratio = 60%

Based on the above information

The computation of the P/E ratio is shown below

But before that, we need to do the following calculations

As we know that

Payout ratio = (1 - plowback ratio )

= (1 - 0.6 )

= 0.4

Now

Growth rate = ROE × Retention ratio

=  0.15 × 0.60

= 9%

And,

Dividend for next period i.e D1 is

= EPS × Payout ratio

= $6 × 0.4

= $2 .4

So,

Current price = D1 ÷ ( Market capitalization rate - Growth rate )

= $2.4 ÷ ( 0.14 - 0.09 )

= $48

And, finally

P/E ratio is

= (Current price) ÷ (EPS)

= $48 ÷ $6

= 8