Finance Assignment Help With DDM And The Earning Multiplier

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8.3.1 DDM and the Earning Multiplier

Earnings multiplier model (or P/E)

P/E = current market price of stock/expected 12 month earnings per share

Using the previous formula we can rewrite the P/E as,

P/E = (D1/E1)/(k-g)

So P/E is dependent on:

  • The expected dividend payout ratio, D1/E1
  • The estimated required rate of return, k
  • The expected growth rate of dividends, g

Example:

If a firm has a dividend payout ratio of 70%, a required rate of return of 15% and a growth rate of 8% then what will be the estimated P/E?

Answer:

P/E = (D1/E1)/(k-g)

P/E = .70/(.15-.08)

P/E = 10.0

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