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PE Ratio and PVGO

# PE Ratio and PVGO - HAAS SCHOOL OF BUSINESS UNIVERSITY OF...

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H AAS S CHOOL OF B USINESS U NIVERSITY OF C ALIFORNIA AT B ERKELEY UGBA 103 A VINASH V ERMA P RICE E ARNINGS R ATIOS AND G ROWTH O PPORTUNITIES : A N E XAMPLE The common stock of XYZ Inc. is expected to pay a dividend of \$12.00 for each share exactly one year from now. Given the risk of the stock, the market requires a rate of return of 16%. The dividends are expected to grow in perpetuity at a constant rate of 8%. (i): What is the current market price of stock of the firm? \$150.00 = - = - = . 150 \$ 08 . 0 16 . 0 12 \$ 1 0 g r D P (ii): Assume that the firm has a stable retention ratio of 40%. Given the expected dividend of \$12.00 next year, work out the earnings per share that can be expected to occur at t=1 . Given that the retention ratio, α , is 40%, and since ) 1 ( 1 1 - = E D , we have: 20 \$ 6 . 0 12 \$ 1 1 1 = = - = D E . (iii): Now, suppose we are also given that the earnings retained in the business generate a return of 20%. Assume that the retained earnings are used entirely for new investments and that assets in place are replaced in perpetuity by accumulated depreciation. What is the present value of earnings per share from the assets in place? The present value of earnings per share from the assets in place is given by:

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PE Ratio and PVGO - HAAS SCHOOL OF BUSINESS UNIVERSITY OF...

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