Castles in the Sand generates a rate of return of 16% on its investments and mai
ID: 2800946 • Letter: C
Question
Castles in the Sand generates a rate of return of 16% on its investments and maintains a plowback ratio of .60. Its earnings this year will be $5 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 .50. (Do not round intermediate calculations. Round your answers to 2 decimal places.) Price $ P/E ratio
Explanation / Answer
Return on investment,ROI = 16%
Blowback (Retention) ratio = 0.60
Growth rate,g = ROI * Retention ratio = 16% * 0.60 = 9.6%
EPS1 = $5
DPS1 = EPS1*(1 - Retention ratio)
= $5*(1 - 0.60)
= $2
Required rate of return, RR = 12%
Current price of stock, P0 = DPS1/(RR - g)
= $2 / (12% - 9.6%)
= $83.333
P/E Ratio = P0 / EPS1
= $83.333 / $5
= 16.667 Times
If the blowback ratio = 0.50
Growth rate, g = 16% * 0.50 = 8%
Current price of stock, P0 = $2 / (12% - 8%) = $50
P/E Ratio = P0 / EPS1 = $50 / $5 = 10 Times
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.