The market capitalization rate on the stock of Flexible Dividend Company is 12%.The expected ROE is 13% and the expected EPS are $3.60.If the firm's plowback ratio is 75%,the P/E ratio will be _______.

Question

Quizplus · Accepted Answer

Plowback ratio (b) = 0.75
Therefore, Retention ratio = (1 - b) = 0.25

Gordon Growth Model can be used to find the P/E ratio:
P/E ratio = (Dividend payout ratio / Rate of return on equity - Dividend growth rate)

Dividend payout ratio = (1-b) = 0.25
Rate of return on equity (k) = ROE = 13%
Dividend growth rate (g) = ROE × Retention ratio = 13% × 0.25 = 3.25%

Plugging in the values:
P/E ratio = (0.25 / (0.13 - 0.0325)) = 11.11

Therefore, the P/E ratio will be 11.11. Option D is the correct choice.

The Market Capitalization Rate on the Stock of Flexible Dividend