The market capitalization rate for Admiral Motors Company is 10%. Its expected ROE is 15% and its expected EPS is $7. If the firm's plowback ratio is 50%.
a) Calculate the growth rate.
b) What will be its P/E ratio?
Sustainable Growth Rate:
The sustainable growth rate of a firm is the maximum rate of growth a firm can sustain without changing its capital structure. In this case, the firm's total assets will grow in proportion to its total equity and total debt.
Answer and Explanation:
a) We can use the following formula to compute the growth rate:
- sustainable growth rate = ROE *plowback ratio
- sustainable growth rate = 15% * 50%
- sustainable growth rate = 7.5%
b) We can use the dividend growth model to compute the price of the stock:
- price per share = dividend per share *(1 + growth rate) /(required return - dividend growth rate)
- price per share = 7 * (1 - 50%) * (1 + 7.5%) / (10% - 7.5%)
- price per share = 150.5
The price-earnings (PE ratio) = price per share / earnings per share = 150.5 / 2.7 = 55.74
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from Finance 101: Principles of FinanceChapter 14 / Lesson 3