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**CFA Practice Question**

An analyst has gathered the following information about a firm:

- Projected sales per share: $30.
- Profit margin: 18%.
- Book value per share: $45.
- Interest free rate: 3%.
- Earnings retention rate: 40%.
- Required rate of return: 12%.
- Debt/Equity ratio: 2:3.

The justified P/S ratio for the company is:

A. 1.57

B. 1.54

C. cannot determine as the earnings growth rate g is not given.

**Explanation:**The earnings growth rate g = retention rate x profit margin x sales / book value = 0.4 x 0.18 x 30 / 45 = 4.8%.

P/S ratio = profit margin x payout ratio x growth factor / (required rate of return - growth rate) = 0.18 x 0.6 x 1.048 / (0.12 - 0.048) = 1.572.

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**User Contributed Comments**
5

User |
Comment |
---|---|

americade |
i thought the justified P/S was 1+g/r-g i don't get Profit Margin X Payout X Growth/r-g. what if there is no dividend? |

americade |
also, can we then say that ROE has an alternative computation of Profit Margin X Sales p/s / BVPS? |

juansaez |
Nice question |

ThePessimist |
The "project sales" in this question refers to sales from *last* year (like the earnings in a trailing P/E ratio). |

saaythong |
americade, P/CF=(1+g)/(r-g). This is talking about the growth in cash flow. Also, the growth in this equation is growth in earnings I believe. |