Consider Company a with a Zero Earnings Retention Ratio and a Real

question 10

Essay

Consider Company A with a zero earnings retention ratio and a real growth rate in earnings of
$\gamma$ %. In an inflationary environment, the company can only pass inflation through its earnings
at a flow-through rate of $\lambda$ %. So if I is the inflation rate, its earnings will grow at a rate of
g = $\gamma$ + $\lambda$ I. The real rate of return required for this company is $\rho$ , so the nominal rate of return required is r== $\rho$ + I.
Use a simple dividend discount model (DDM) assuming that dividends will grow indefinitely at a constant compounded annual growth rate (CAGR), g = $\gamma$ + $\lambda$ I.
a. Derive formulas equivalent of Equations (6.7) and (6.8), which assumed no real growth in earnings. Discuss the results.
b. Use these formulas to calculate P/E ratio on prospective earnings with the following data on Company A: $\gamma$ = 2%, I = 4%, $\rho$ = 4%, $\lambda$ = 100%.
c. Same question for a Company B, whose inflation pass-through rate is only 80%.

---

Definitions:

Neuron

A neuron, which serves as the foundational unit of the nervous system, crucial for conveying information all over the body.

Absolute Refractory Period

A time during which a neuron is unable to fire another action potential, no matter how strong the incoming stimulus.

Neuron

The basic working unit of the brain, a specialized cell designed to transmit information to other nerve cells, muscle, or gland cells.

Axon

A long, threadlike part of a nerve cell along which impulses are conducted from the cell body to other cells.