Hello all,
I attach the question here
The answer key says to use the formula: Justified P/B = (ROE - g) / (r - g), which gives 2.41 as the answer. I understand this.
But why is the following approach below wrong?
Using DDM:
V0 = (1.35*1.076)/(0.14-0.076) = 22.696
EPS = 1.35/0.67 = 2.0149
BVPS = EPS/ROE = 2.0149 / 0.23 = 8.760545
Thanks!
The numbers in question don’t exactly match so there are some rounding issues
g = ROE x retention
g = 23% x (1 - 0.67) = 7.59%
But also you need to grow your estimate of book 8.760545 by the growth rate to get the next year.
In reconciling the two formulas.
ROE = Eanings this yr/ Book start of year.
Then you do
BVPS = EPS/ROE = 2.0149 / 0.23 = 8.760545
You used EPS at year 0
so BVPS is at year minus 1
Justified price to book formula is Price/Book year zero.
