NISM Certifications · NISM-Series-XV: Research Analyst · Valuation Principles
A firm has EPS of Rs 20, a payout ratio of 40% and a required return of 15%. Its sustainable growth is 10% and its dividend is expected to grow at this rate. Using the Gordon model with D1 = D0 x (1+g), what is the justified trailing P/E ratio?
The justified trailing P/E is 8.8. It equals payout ratio times one plus growth, divided by cost of equity minus growth: 0.4 x 1.10 divided by 0.05. This gives a value of Rs 176 on EPS of Rs 20.
- A8.0
- B8.8Correct
- C6.0
- D16.0
Explanation
Justified trailing P/E = payout x (1+g)/(ke - g) = 0.4 x 1.10/(0.15 - 0.10) = 0.44/0.05 = 8.8. Check: D0 = 8, D1 = 8.8, value = 8.8/0.05 = 176 = 8.8 x 20. Using 0.4/0.05 = 8.0 omits the growth factor.
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