CFA Practice Question

CFA Practice Question

When using the P/E version of the Dividend Discount model, ______

I. a lower growth rate will give you a lower P/E ratio.
II. a lower required return will give you a higher P/E ratio.
III. a higher payout ratio will give you a higher P/E ratio (assuming all else stays constant).
A. II and III.
B. I and III.
C. I, II and III.
Explanation: r = D1/P0 + g, and g = (1.0 - Payout rate) (ROE)

User Contributed Comments 4

User Comment
chandsingh Correct me if iam wrong but iii is correct because the higher dividend payout will increase the numerator making up for any decrease in Growth?
acemaj why is I true?
asalonga7 Using the gordon growth model these answers arent hard to work through: Po = D1/ (k-g)

1 - lower growth means larger denominator = lower price
2 - lower required rate means smaller denom = higher price
3 - agree with chandsingh - payout ratio directly affects the numerator while it is being multiplied by another percentage in the denominator - more of an increase in D1 => higher numerator=higher price
forry9er P/E = Payout rate / Rr - g
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