Current index price 80.00 Equity Risk Premium 9.0% Estimated dividend next period 1.20 Estimated earnings next period $ 8.00 Financial Leverage 0.80 Government bond rate 6.8% Net Profit Margin 12.0% Total Asset Turnover 1.80 Your answer: C was incorrect. The correct answer was B) 36.6%. Using the earnings multiplier approach, we will multiply the earnings multiplier (the justified P/E ratio) by the expected earnings to get an expected future price. Adding in the expected dividend, we can then estimate an expected rate of return. To calculate the earnings multiplier, we first need the growth rate for the market, which is the retention ratio times the return on equity (ROE). The dividend payout is $1.20 out of $8.00 in earnings so the retention ratio is $6.80/$8.00 = 85%. Using duPont analysis, the ROE is the net profit margin times the total asset turnover ratio times the financial leverage: 12% × 1.80 × 0.80 = 17.28%. The growth rate is then 85% × 17.28% = 14.69%. We will also need the dividend payout ratio and the required return on stock. The former is just one minus the retention ratio or 1 - 0.85 = 15%. The required return on equity is the government bond rate plus the equity risk premium: 6.8% + 9% = 15.8%. The equity multiplier is the dividend payout ratio divided by the required return on equity minus the growth rate: 0.15 / (0.158 - 0.1469) = 13.51. The expected future price of the series is the earnings multiplier times the future earnings: 13.51 × $8.00 = 108.08. The expected return is the expected dividend plus the price change in the series divided by the original price: ($1.20 + $108.08 - $80.00) / $80.00 = 36.60%. Your answer may differ by a few tenths of a percent depending on how many decimal places you carried intermediate calculations to. If you used your calculator’s memory throughout, the return would have been calculated as 36.39%.
My question is: The expected future price of the series is the earnings multiplier times the future earnings: 13.51 × $8.00 = 108.08 Isn’t this Po (current price)? Schweser Book 3 page 17 has the formula To get the future price shouldn’t we calculate 108.08 x (1+g) ?
Yes, I am much confused by Schweser too !
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Panda2005 Wrote: ------------------------------------------------------- > My question is: > > The expected future price of the series is the > earnings multiplier times the future earnings: > 13.51 × $8.00 = 108.08 > > Isn’t this Po (current price)? Schweser Book 3 > page 17 has the formula > > To get the future price shouldn’t we calculate > 108.08 x (1+g) ? Justified P/E is Po/E1 and you are given E1 - so if you multiply them together you are left with Justified Po (or the intrinsic value of the market) which is not the same as the current price of the market.
this is what I think the formula given by ddm P0/E1 uses the LEADING/FORWARD P/E ratio. usually the TRAILING P/E Ratio is used. So we determine the P/E ratio to be used. but valuation is used on Po/Eo as an industry standard. That means that using E1 we actually get P1.
I get what you are trying to say. But Po is the “intrinsic CURRENT value”, what we want is “intrinsic FUTURE value”, so don’t we need to multiply 1+g? mwvt9 Wrote: ------------------------------------------------------- > Panda2005 Wrote: > -------------------------------------------------- > ----- > > My question is: > > > > The expected future price of the series is the > > earnings multiplier times the future earnings: > > 13.51 × $8.00 = 108.08 > > > > Isn’t this Po (current price)? Schweser Book 3 > > page 17 has the formula > > > > To get the future price shouldn’t we calculate > > 108.08 x (1+g) ? > > Justified P/E is Po/E1 and you are given E1 - so > if you multiply them together you are left with > Justified Po (or the intrinsic value of the > market) which is not the same as the current price > of the market.