Saved Help Save & Exit Submi Check my work Castles in the Sand generates a rate

Question

Saved Help Save & Exit Submi Check my work Castles in the Sand generates a rate of return of 16% on its investments and maintains a plowback ratio of 060. Its earnings this year will be $5 per share. Investors expect a rate of return of 12% 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 0.50. (Do not round intermediate calculations. Round your answers to 2 decimal places.) Price P/E ratio

Explanation / Answer

Plowback ratio 0.6 Payout Ratio = (1-0.60) 0.4 Sustainable growth rate = Return on Equity * (1 – Dividend Payout Ratio) SGR (g) = 16% x .60 9.60% Dividend Paid (D0) = $5 x (1 - .60) $2 Rate of Return (r) 12.00% Current Price = P0 = D0 x (1+g)/r-g P0 = $2 x (1+9.60%)/(12% - 9.60%) $91.33 P/E Ratio = $91.33/5 18.27 If the plowback ratio is reduced to 0.50 Plowback ratio 0.5 Payout Ratio = (1-0.50) 0.5 Sustainable growth rate = Return on Equity * (1 – Dividend Payout Ratio) SGR (g) = 16% x .50 8.00% Dividend Paid (D0) = $5 x (1 - .50) $2.5 Rate of Return (r) 12.00% Current Price = P0 = D0 x (1+g)/r-g P0 = $2.5 x (1+8%)/(12% - 8%) $67.5 P/E Ratio = $67.50/5 13.50

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