Increases in the riskiness of Sundanci stock would be expected
to lower the P/E ratio.
The P/E ratio is an increasing function of the growth rate of the firm; the higher
the expected growth the higher the P/E ratio.
Sundanci would command a
higher P/E if analysts increase the expected growth rate.
The P/E ratio is a decreasing function of the market risk premium.
An
increased market risk premium would increase the required rate of return,
lowering the price of a stock relative to its earnings.
A higher market risk
premium would be expected to lower Sundanci's P/E ratio.
12.
a.
The sustainable growth rate is equal to:
plowback ratio × return on equity = b × ROE
where
b = [Net Income – (Dividend per share × shares outstanding)]/Net Income
ROE = Net Income/Beginning of year equity
In 2000:
b = [208 – (0.80 × 100)]/208 = 0.6154
ROE = 208/1380 = 0.1507
Sustainable growth rate = 0.6154 × 0.1507 = 9.3%
In 2003:
b = [275 – (0.80 × 100)]/275 = 0.7091
ROE = 275/1836 = 0.1498
Sustainable growth rate = 0.7091 × 0.1498 = 10.6%
b.
i. The increased retention ratio increased the sustainable growth rate.
Retention ratio = [Net Income – (Dividend per share × shares outstanding)]/Net Income
Retention ratio increased from 0.6154 in 2000 to 0.7091 in 2003.
This increase in the retention ratio directly increased the sustainable growth
rate because the retention ratio is one of the two factors determining the
sustainable growth rate.
ii. The decrease in leverage reduced the sustainable growth rate.
Financial leverage = (Total Assets/Beginning of year equity)
Financial leverage decreased from 2.34 (= 3230/1380) at the beginning of 2000
to 2.10 at the beginning of 2003 (= 3856/1836)
This decrease in leverage directly decreased ROE (and thus the sustainable
growth rate) because financial leverage is one of the factors determining ROE
(and ROE is one of the two factors determining the sustainable growth rate).
186
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View Full Document13.
a.
The formula for the Gordon model is:
V
0
= [D
0
× (1 + g)]/(r – g)
where:
D
0
= dividend paid at time of valuation
g = annual growth rate of dividends
r = required rate of return for equity
In the above formula, P
0
, the market price of the common stock, substitutes
for V
0
and g becomes the dividend growth rate implied by the market:
P
0
= [D
0
× (1 + g)]/(r – g)
Substituting, we have:
58.49 = [0.80 × (1 + g)]/(0.08 – g)
⇒
g = 6.54%
b.
Use of the Gordon growth model would be inappropriate to value
Dynamic’s common stock, for the following reasons:
i. The Gordon growth model assumes a set of relationships about the growth
rate for dividends, earnings, and stock values.
Specifically, the model
assumes that dividends, earnings, and stock values will grow at the same
constant rate.
In valuing Dynamic’s common stock, the Gordon growth
model is inappropriate because management’s dividend policy has held
dividends constant in dollar amount although earnings have grown, thus
reducing the payout ratio.
This policy is inconsistent with the Gordon model
assumption that the payout ratio is constant.
ii. It could also be argued that use of the Gordon model, given Dynamic’s
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 Spring '13
 Ohk
 Dividend yield, P/E ratio, PEG ratio

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