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CMA Final · Strategic Financial Management · Fundamental Analysis and Technical Analysis

A company's EPS is Rs 12, its dividend payout ratio is 40% and its expected constant growth rate is 5%. The required return on equity is 15%. Using the Gordon model with the Rs 12 as the current year's EPS (D0 = payout x EPS), what is the justified price-earnings multiple (P/E on current earnings)?

The justified P/E is 4.2. The current dividend is Rs 4.80, the next dividend is Rs 5.04, and the Gordon value is 5.04 divided by 10%, which is Rs 50.40. Dividing by EPS of Rs 12 gives 4.2. Using D0 instead of D1 understates the value.

  1. A4.0
  2. B4.2Correct
  3. C10.5
  4. D6.67

Explanation

D0 = 0.40 x 12 = Rs 4.80. D1 = 4.80 x 1.05 = Rs 5.04. P0 = 5.04/(0.15-0.05) = Rs 50.40. P/E = 50.40/12 = 4.2. The option 4.0 uses D0/(k-g) without growing the dividend, giving 48/12.

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