CFA CFA Level 1 Question of the Week – Equity

Question of the Week – Equity

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    • Avatar of AdaptPrepAdaptPrep
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        You are provided the following information about a
        company Shoes4You:

         Current stock price: $35

        • Shares outstanding:
          1,000,000
        • Past year earnings:
          $4,000,000
        • Net book value:
          $28,000,000
        • Past year free cash flow:
          $8,000,000
        • Dividend payout ratio: 20%
        • Cost of equity capital:
          11%
        • Expected dividend growth
          rate: 3%

         The justified forward P/E ratio for Shoes4You is closest to:

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      • Avatar of AdaptPrepAdaptPrep
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          Based on the information we are provided, we can use the
          Gordon growth model (which is the same model used in the text for this
          problem):

          P0 = D1 / (r – g)

           

          The justified P/E ratio based on this model is:

          P0 / E1 = (D1 / E1) / (r – g) = p / (r – g)

           

          where

          p is the dividend payout ratio (20%)

          r is the cost of equity capital (11%)

          g is the expected dividend growth rate (3%)

           

          We then have:

          P0 / E1 = 0.2 / (0.11 – 0.03) = 2.5

           

          The P/E ratio is Price/Earnings Per Share. The stock
          price is $35. Earnings per share are $4,000,000 / 1,000,000 = $4. The P/E ratio
          then is $35/$4 = $8.75.

        • Avatar of riteshbadairiteshbadai
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            is the answer 1 

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