Following is a graph of the Industry Life Cycle with the names of the phases omitted.
Using the graph above, which of the following choices is CORRECT?
Click on the arrows to vote for the correct answer
A. B. C. D.D
Phase D represents the Stabilization and Market Maturity Phase. Corporate finance shows that a mature company has a return on equity (ROE) approximately equal to the required rate of return, ke. Then, the formula:
P/E = (dividend payout) / (ke"" retention rate * ROE) becomes
= (1 "" retention rate) / (ke"" retention rate * ke) = 1/ke
The other statements are incorrect. The infinite period dividend discount model is most likely not appropriate for a firm in Phase B, which represents the rapid accelerating growth phase (the multi-stage model is best). Remember that the infinite period DDM is most useful for a company with the following assumptions:
Phase B, the Rapid Accelerating Growth phase, is characterized by limited competition and very high sales and profit margin growth. Companies in this phase likely have supernormal growth. Competition increases in Phase C, the mature growth phase. The industry growth rates approach that of the economy in Phase D,
Stabilization and Market Maturity. Phase E is the Deceleration of Growth and Decline phase. During this phase, demand shifts away from the industry and growth of substitute products may cause growth rates to be negative.