Justified P/E ratio

CFA Level I Equities
#1

what will happen to justified P/E ratio if the payout ratio increases? assuming the growth rate is constant.

the answer is increase. could some body explain why?

g = ROE*(1-Payout Ratio)

so P/E = (D1/E)/(R-g)

If g decreases with increase in payout ratio why would P/E increase it should decrease. What am I missing?

Thanks

#2

Which is it? Is g constant, or is g decreasing?

You can’t have it both ways.

#3

“G is constantly decreasing”

#4

G is constant according to the question.

But my though process was that if payout ratio increases than g will decrease comparing this with the state when payout ratio does not decrease.After initial decrease growth rate is constant.

#5

Why will g decrease?

Put another way, what assumption are you making when you say that g will decrease?

(Note: it is quite important that you realize the assumption you’re making; before I asked, you probably didn’t realize that you were making one.)

#6

g = ROE*(1-Payout Ratio)

if initially payout ratio is 40% and it increases to 70% keeping ROE constant new g will be ROE*.3 were as initially g was ROE*.6 hence g decreases.

#7

Once again, you’re insisting that g decreases when we’ve stipulated that g doesn’t change.

Go back through your calculation with g remaining constant and tell me what assumption you’re making. As a hint, you stated it explicitly just now.