Over the past few years,Swanson Company has retained,on the average,70 percent of its earnings in the business.The future retention rate is expected to remain at 70 percent of earnings,and long-run earnings growth is expected to be 10 percent.If the risk-free rate,rRF,is 8 percent,the expected return on the market,rM,is 12 percent,Swanson's beta is 2.0,and the most recent dividend,D0,was $1.50,what is the most likely market price and P/E ratio (P0/E1)for Swanson's stock today?

Question

Quizplus · Accepted Answer

The expected return using CAPM is 16% (8% + 2*(12%-8%)). The growth rate is 10%, and the dividend is $1.50. Using the Gordon Growth Model: P0 = D1 / (r - g) = 1.65 / (0.16 - 0.10) = $27.50. The P/E ratio is calculated as P0/E1 = $27.50 / $5.50 = 5.0x.

Over the Past Few Years,Swanson Company Has Retained,on the Average,70