CFA Practice Question

CFA Practice Question

An analyst gathered the following information about a stock market index:

Required rate of return 16%
Expected dividend payout ratio 30%
Expected return on equity investment 20%

The expected price/earnings (P/E) ratio of the index is closest to:
A. 3.5
B. 7.0
C. 15.0
Explanation: Growth rate = (1 - payout ratio) x ROE = (1 − 0.3) x 20% = 14% = 0.14
P/E = payout ratio / (required return - growth rate) = 0.3 / (0.16 − 0.14) = 15.0.

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