Payout Ratio and P/E Ratio Relationship

C

P/E ratio = (Payout ratio)/(k - g); i.e. the relationship is positive.

Based on the P/E (Price-to-Earnings) equation, there is a relationship between the payout ratio and the P/E ratio. The correct answer would depend on the interpretation of the terms involved.

The P/E ratio is calculated by dividing the market price per share of a company's stock by its earnings per share (EPS). It is a commonly used valuation ratio that provides insight into how much investors are willing to pay for each dollar of earnings generated by the company.

On the other hand, the payout ratio represents the proportion of earnings that a company distributes to its shareholders in the form of dividends. It is calculated by dividing the dividends per share by the earnings per share.

Now let's examine the possible answers:

A. No: This answer suggests that there is no relationship between the payout ratio and the P/E ratio. However, this is not correct because the payout ratio can indeed influence the P/E ratio.

B. A negative: This answer suggests that there is a negative relationship between the payout ratio and the P/E ratio. In other words, as the payout ratio increases, the P/E ratio decreases. This interpretation is incorrect because a higher payout ratio, which means more earnings are being distributed as dividends, can lead to a higher P/E ratio, not a lower one.

C. A positive: This answer suggests that there is a positive relationship between the payout ratio and the P/E ratio. In this case, as the payout ratio increases, the P/E ratio also increases. This interpretation is accurate. When a company has a higher payout ratio, it indicates that a larger proportion of its earnings is being distributed to shareholders. This can be seen as a positive signal, as investors may consider higher dividends as a sign of financial strength and confidence in the company's future prospects. Consequently, investors may be willing to pay a higher price for each dollar of earnings, leading to an increase in the P/E ratio.

Therefore, the correct answer is C. A positive relationship exists between the payout ratio and the P/E ratio.