An decrease in the required rate of return will have what effect on the earnings multipliers of common stocks? Further, what effect could be expected from a decrease in the dividend payout ratio?
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A. B. C. D. E.E
A simple method of determining the appropriate earnings multiplier for a common stock can be found by manipulating the Infinite Period Dividend Discount Model such that it resembles the following:
P/E = [(d1/e1) / (k - g)]
Where: P/E = the earnings multiplier expressed as the Price-to-Earnings Ratio, d1/e1 = the dividend payout ratio at t1, k = the required rate of return, and g = the anticipated annual growth rate.
As you can see, a decrease in the required rate of return, holding everything else equal, will lead to an increase in the earnings multiplier. Opposite this effect, a decrease in the dividend payout ratio will lead to a decrease in earnings multiplier.