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No-Growth Industries pays out all of its earnings as dividends. It will pay it's next $6 per...

Question:

No-Growth Industries pays out all of its earnings as dividends. It will pay it's next $6 per share dividend in a year. The discount rate is 14%.

a. What is the price-earnings ratio of the company?

b. What would the PIE ratio be if the discount rate were 10%?

Dividend Payout Ratio and Sustainable Growth Rate:

The dividend payout ratio indicates the fraction of net income that a firm pays out as dividend. The higher the dividend growth rate, the lower the sustainable growth rate a firm can have.

Answer and Explanation:

a. If the firm pays all dividends, then its retention ratio is zero. In this case, the firm has no growth, and thus the growth rate is zero. The price of the stock, according to the dividend growth mode, is:

  • price per share = next dividend / (discount rate - dividend growth rate)
  • price per share = 6 / (14% - 0)
  • price per share = 42.86

The price-earnings ratio = price per share / earnings per share = 42.86 / 6 = 7.14. Note that earnings per share is the same as dividend per share since the firm pays out all earnings as dividends.

b. If the discount is 10%, then the price per share = 6 / (10% - 0) = $60.


Learn more about this topic:

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The Dividend Growth Model

from Finance 101: Principles of Finance

Chapter 14 / Lesson 3
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