Castles in the Sand generates a rate of return of 15% on its investments and mai

Question

Castles in the Sand generates a rate of return of 15% on its investments and maintains a plowback ratio of .50. Its earnings this year will be $6 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 .40. (Do not round intermediate calculations. Round your answers to 2 decimal places.) Price P/E ratio

Explanation / Answer

ANs A.

Given EPS=6, rate of return = 15%, cost of equity =12%, Plowback ratio is how much company retains its profit and 1- plowback ratio is equal to dividend payout

Therefore book value of share is EPS/ (1+rateof return)

=6/1.15

= 5.21

Dividentd paid = 50% i.e $3 therefore price of share , = (3/1.12)+ (6/1.2)

=2.68 +5.36 = 8.04

PE ratio is =MPS/EPS = 8.04/6=1.34

ANS B Divdend paid 60% i.e =6*0.6 = 3.6

price of share = 3.6/1.12 + 6/1.12

= 3.21+5.36 =8.57

EPS =8.57/6 i.e. 1.43

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