Final answer:
The justified forward price-to-earnings (P/E) ratio for Flexsteel Company, considering a market-capitalization rate of 12%, an expected ROE of 15%, expected EPS of $3.50, and a plowback ratio of 30%, is 32.67.
Step-by-step explanation:
The question pertains to calculating the justified forward price-to-earnings (P/E) ratio for Flexsteel Company, where the market-capitalization rate is 12%, the expected return on equity (ROE) is 15%, and the expected earnings per share (EPS) are $3.50. Additionally, the firm's plowback ratio, which is the portion of earnings reinvested into the company, is 30%.
To find the justified forward P/E ratio, we use the formula for the Gordon Growth Model which incorporates these figures (P/E= (D1/E1)/(k-g)). The dividend payout ratio is 1 minus the plowback ratio, so D1, the expected dividend per share, will be 70% of the EPS.
Given the plowback ratio of 30%, we can calculate the growth rate (g) as the plowback ratio times the ROE, in this case, 0.30 * 0.15 = 0.045 or 4.5%.
Using the formula (P/E = (D1/E1)/(k-g)), where D1/E1
= EPS * (1 - plowback ratio),
the P/E ratio would be (($3.50 * (1 - 0.30))/(0.12 - 0.045)),
which simplifies to (($3.50 * 0.70)/0.075).
Calculating this gives a justified forward P/E ratio of 32.67.