Explanation

Using the Gordon growth model, the justified forward P/E ratio can be calculated as:

Formula: $\text{Justified P/E} = \frac{D_1/E_1}{r - g} = \frac{\text{Payout Ratio}}{r - g}$

Where:

• $D_1/E_1$ = Dividend payout ratio = 45% = 0.45
• $r$ = Required rate of return = 10% = 0.10
• $g$ = Growth rate = 7% = 0.07

Calculation: $\text{Justified P/E} = \frac{0.45}{0.10 - 0.07} = \frac{0.45}{0.03} = 15$

Step-by-step reasoning:

1. The Gordon growth model formula for price is: $P_0 = \frac{D_1}{r - g}$
2. For forward P/E, we use: $\frac{P_0}{E_1} = \frac{D_1/E_1}{r - g}$
3. $D_1/E_1$ is the dividend payout ratio = 45%
4. The denominator $r - g$ = 10% - 7% = 3%
5. 45% ÷ 3% = 15

Note: The EPS forecast of $0.60 is not needed for this calculation since we're calculating a ratio (P/E), not the absolute price.

Answer verification:

• Option A: 15 ✓ (Correct)
• Option B: 18 (Incorrect)
• Option C: 20 (Incorrect)

The justified forward P/E is exactly 15, making option A the correct choice.