Given that the retention rate of earnings of a firm is 0.30, the required rate of return on its stock is 17%, the expected growth rate is 12%, and expected 12 month earnings per share are $2.32, what should the current market price of the stock be?
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A. B. C. D. E. F.C
According to the earnings multiplier model, the price/earnings ratio is equal to the dividend payout ratio divided by the spread between the required rate of return and the expected growth rate. The dividend payout ratio is equal to 1 - the retention rate of earnings (everything the firm does not retain is paid out in dividends).
In this question, it is 1 - 0.30 = 0.70. The P/E ratio is thus equal to 0.70 / (0.17 - 0.12) = 14. Multiplying the P/E ratio by earnings per share yields the current market price. In this question, it is 14 x
2.32 = $32.48.