ABC company retains about half of its earnings each year and pays the rest out as dividend. Recently, the company paid a $3.25 dividend. Investors expect the company's dividends to grow modestly in the future, about 4 per cent per year, and they require a 9 percent return on ABC shares.

(I) Based on next year's earning forecast, what is ABC's price/earning ratio (P/E) ratio ? ( Show complete workings)

(ii) Retaining the original assumption of 4% growth, how would the price/earning ratio change if investors became convinced that ABC was not a very risky and were willing to accept a 7% return on their shares going forward?

Answer rating: 100% (QA)

To solve this problem we need to use the dividend discount model DDM to determine the priceearnings ... View the full answer