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Please explain the logic behind this solution for an MCQ question I saw in an open tuition mock.
Dividend yield= 8%; dividend cover= 2.4
Question: what is the P/E ratio?Solution:
Dividend yield= dividend/market value =0.08
Therefore market value = dividend/0.08 = 12.5 × dividend
Dividend cover =earnings/dividend =2.4
Therefore earning= 2.4 x dividendPE = MV/earnings =12.5 × dividend/2.4 × dividend = 5.21
How did they get 12.5? Why? And can you please explain the last equation for the P/E ratio?
The market value = dividend / 0.08 which is the same as (12.5 x dividend) because 1/0.08 = 12.5
The PE ratio is the MV / earnings. Since the MV is 12.5 x dividend, and the earnings are 2.4 x dividend, then MV / earnings = (12.5 x dividend) / (2.4 x dividend) .
Divide top and bottom by ‘dividend’ and you get PE ratio = 12.5 / 2.4 = 5.21
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