Person C and Person GR are the founders and owners of the R Company. This company manufactures and installs heating, ventilation, and cooling units (HVAC) commercially. Both the owners have 50,000 shares of company’s stock as per the partnership deed. They wanted to sell their stocks and decided to value their holding in the company. R Company has earnings per share of $3.15 and the dividends of $45,000 each were paid to the owners of the company. Moreover, there is even return on equity (ROE) of 17% and the required rate of return is 14%. Characters in the case: R Company: The firm that wants to value their stocks Person C: Co-owner of Company R Person GR: Co-owner of Company R To discuss: On the expression for the price-earnings ratio that imply about the relationship between the required return, return on equity of the company, and dividend payout ratio. Introduction: A company’s market price per share to its earnings per share is termed as price earnings ratio . This ratio assists in stock selection. The rate of return refers to the loss or gain incurred on the investment made by the company. Return on equity (ROE) measures the profitability of the company by indicating profit generated from the money invested by the shareholders.

Question

Want to see the full answer?

Answer 1

Question

Chapter 8, Problem 4M

Summary Introduction

Case summary:

Person C and Person GR are the founders and owners of the R Company. This company manufactures and installs heating, ventilation, and cooling units (HVAC) commercially. Both the owners have 50,000 shares of company’s stock as per the partnership deed. They wanted to sell their stocks and decided to value their holding in the company.

R Company has earnings per share of $3.15 and the dividends of $45,000 each were paid to the owners of the company. Moreover, there is even return on equity (ROE) of 17% and the required rate of return is 14%.

Characters in the case:

R Company: The firm that wants to value their stocks

Person C: Co-owner of Company R

Person GR: Co-owner of Company R

To discuss: On the expression for the price-earnings ratio that imply about the relationship between the required return, return on equity of the company, and dividend payout ratio.

Introduction:

A company’s market price per share to its earnings per share is termed as price earnings ratio. This ratio assists in stock selection. The rate of return refers to the loss or gain incurred on the investment made by the company.

Return on equity (ROE) measures the profitability of the company by indicating profit generated from the money invested by the shareholders.

Expert Solution & Answer

Want to see the full answer?

Check out a sample textbook solution

See solution

Students have asked these similar questions

Apart from using PE ratio, what is another way of valuing the stock price? if we have the EPS, Share Price, Dividend Per Share, ROE and the discount rate (R). And what are the assumptions and the limitations of this model? What can be said about the dividend growth model? Similarly what can be said about the capital asset pricing model?

If the Modigliani and Miller hypothesis about dividends is correct, and if one found a group of companies which differed only with respect to dividend policy, which of the following statements would be most correct? Group of answer choices None of these statements is true. All of these statements are true. The total expected return, which in equilibrium is also equal to the required return, would be higher for those companies with lower payout ratios because of the greater risk associated with capital gains versus dividends. If the expected total return of each of the sample companies were divided into a dividend yield and a growth rate, and then a scatter diagram (or regression) analysis were undertaken, then the slope of the regression line (or b in the equation D1/P0 = a + b(g)) would be equal to +1.0. The residual dividend model should not be used, because it is inconsistent with the MM dividend hypothesis.

Which of the following is the best reason why the price-earnings method is often used by investors to estimate the fair price of a stock? a) Because the earning multiples are easily found in online financial databases. b) Earnings per share is a known amount that is related to the payment of future dividends. c) Because the price-earnings method gives the same answer as the constant growth method and is easier to compute. d) The price-earnings method has been shown to provide the most accurate price estimate.