An investor gathers the following data.
| Year | Earnings per share（$） | Dividends per share（$） | ROE |
| 2011 | 3.20 | 1.92 | 12% |
| 2010 | 3.60 | 1.80 | 17% |
| 2009 | 2.44 | 1.71 | 13% |
| 2008 | 2.50 | 1.60 | 15% |
To estimate the stock's justified forward P/E, the investor prefers to use the compounded annual earnings growth and the average of the payout ratios over the relevant period (i.e., 2008–2011). If the investor uses 11.5% as her required rate of return, the stock's justified forward P/E is closest to:
C is correct.
P0 /E1 = p/(r – g)
Earnings growth rate (g) over the period 2008–2011 = 2.50(1 + g) 3= 3.20; g = 8.6%.
Payout ratio (p) computation (for example, 2011) = 1.92/3.20 = 0.60.
Average payout ratio = (0.60 + 0.50 + 0.70 + 0.64)/4 = 0.61.
P0 /E1 = p/(r – g) = 0.61/(0.115 – 0.086) = 0.61/0.029 = 21.0.