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Hi tutor,
I have a doubt pertaining to question 95 (12/11) from BPP revision kit (up to June 2016 version). Since earnings growth is forecasted to be 5%, why don’t we include the growth into the calculation of value of the company using the earnings yield method?
Earnings yield is always based on the latest earnings and is never affected by growth (just as is the case with the PE method). Earnings yield is the reciprocal of the PE ratio.
Thanks for the reply. I am confused- the BPP study text (page 346) states that earnings growth could be incorporated into the earnings yield method:
Market value = earnings X (1+g) / EY – G
Hope you could help me again on this, thanks.
They should not have brought in growth – the earnings yield is calculated as I wrote in my previous reply.
(The examiner did write in his answer to one question that he would allow the answer if you had brought in growth, but strictly it is not brought in.)
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