An increase in the required rate of return will have what effect on the earnings multipliers of common stocks? Further, what effect could be expected from an increase in the dividend payout ratio?
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A. B. C. D. E.A
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, an increase in the required rate of return, holding everything else equal, will lead to a decrease in the earnings multiplier. Opposite this effect, an increase in the dividend payout ratio will lead to an increase in earnings multipliers.