P/E ratio approach to valuation

Question 9: (10 points). (Relative valuation of common stock) Using the P/E ratio approach to valuation, calculate the value of a share of stock under the following conditions:

  • the investor’s required rate of return is 13 percent,
  • the expected level of earnings at the end of this year (E1) is $8,
  • the firm follows a policy of retaining 40 percent of its earnings,
  • the return on equity (ROE) is 15 percent, and
  • similar shares of stock sell at multiples of 8.571 times earnings per share.

Now show that you get the same answer using the discounted dividend model. (Round to the nearest cent.)

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a. The stock price using the P/E ratio valuation method is:

$

b. The stock price using the dividend discount model is:

$

 
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