CMA Final · Strategic Financial Management · Fundamental Analysis and Technical Analysis
Ananya Ltd. expects EPS of Rs 20 next year. Its payout ratio is 50%, cost of equity is 13% and constant growth is 5%. Using the justified forward P/E from the Gordon model, the stock trades at Rs 140. What is the justified price and the verdict?
The justified price is Rs 125, from a forward P/E of 6.25 (payout 0.5 divided by 13% minus 5%) times EPS of Rs 20. Since the market price of Rs 140 is above this, the stock is overvalued.
- ARs 125; overvaluedCorrect
- BRs 105; overvalued
- CRs 125; undervalued
- DRs 200; undervalued
Explanation
Justified forward P/E = payout/(k-g) = 0.5/(0.13-0.05) = 6.25. Price = 6.25 x 20 = Rs 125. Check: dividend 10/0.08 = 125. Market price Rs 140 exceeds Rs 125, so overvalued.
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