Given that the expected dividend payout ratio on a common stock is 0.7, the required rate of return is 19%, the dividend and earnings growth rate is 15%, and current earnings are $1.38, using the earnings multiplier model, what is the estimated value of the stock?
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A. B. C. D. E.B
The earnings multiplier model postulates that P/E = (D1/E)/(k -g), where P/E is the price to earnings ratio, D1 is next year's expected dividends, E is next year's earnings, k is the required rate of return, and g is the growth rate in dividends. D1/E is also known as the dividend payout ratio. In this question, the P/E is (0.7) /
(0.19 - 0.15) = 17.5. Next year's earnings are equal to current earnings multiplied by the earnings (and dividend) growth rate (1.38 x 1.15 = $1.59). We can multiply P/E by next year's earnings to arrive at our expected stock value ((P/E) x E = P) In this question, the estimated value is 17.5 x 1.59 = $27.83.