Question

Even Better Products has come out with a new and improved product. As a result, the firm projects an ROE of 20%, and it will maintain a plowback ratio of 0.30. Its projected earnings are $4 per share. Investors expect a 13% rate of return on the stock. At what price and P/E ratio would you expect the firm to sell?

Answer 1

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Answer 2

Price = $40

P/E ratio = 10 times

Step-by-step explanation:

The formula to compute the price earning ratio is shown below:

Price-earnings ratio = (Market price per share) ÷ (Earning per share)

where,

Market price per share = Next year dividend ÷ (Required rate of return - growth rate)

Next year dividend equal to

= Earnings × (1 - plow back ratio)

= $4 × (1 - 0.30)

= $2.8

Growth rate is = 20% × 0.30 = 6%

And, the required rate of return is 13%

So, the market price per share would be

= 2.8% ÷ (13% - 6%)

= $40

Now the price earning ratio would be

= $40 ÷ $4

= 10 times