Castles in the Sand generates a rate of return of 15% on its investments and mai
ID: 2743247 • Letter: C
Question
Castles in the Sand generates a rate of return of 15% on its investments and maintains a plowback ratio of .20. Its earnings this year will be $2 per share. Investors expect a 12% rate of return on the stock.
Find the price and P/E ratio of the firm. (Do not round intermediate calculations. Round your answers to 2 decimal places.)
Find the price and P/E ratio of the firm if the plowback ratio is reduced to .10. (Do not round intermediate calculations. Round your answers to 2 decimal places.)
Castles in the Sand generates a rate of return of 15% on its investments and maintains a plowback ratio of .20. Its earnings this year will be $2 per share. Investors expect a 12% rate of return on the stock.
a.Find the price and P/E ratio of the firm. (Do not round intermediate calculations. Round your answers to 2 decimal places.)
Price $ P/E ratio b.Find the price and P/E ratio of the firm if the plowback ratio is reduced to .10. (Do not round intermediate calculations. Round your answers to 2 decimal places.)
Price $ P/E ratioExplanation / Answer
a) Rate of return 15% Plowback ratio 0.2 Sustainable growth rate = ROR x Plowback = .15 x .2 0.03 Expected growth rate 12% Dividend $ 2.00 Next Dividend = 2 x (1+0.03) $ 2.06 Price of stock = Next Dividend / (Expected rate of return - Sustainable growth rate) $ 22.89 PE = Price of stock / earning per stock = 22.89 / 2 11.44 b) Rate of return 15% Plowback ratio 0.1 Sustainable growth rate = ROR x Plowback = .15 x .1 0.015 Expected growth rate 12% Dividend $ 2.00 Next Dividend = 2 x (1+0.015) $ 2.03 Price of stock = Next Dividend / (Expected rate of return - Sustainable growth rate) $ 19.33 PE = Price of stock / earning per stock = 19.33 / 2 9.67
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