Question

Castles in the Sand generates a rate of return of 20% on its investments and maintains a plowback ratio of 0.50. Its earnings this year will be $4 per share. Investors expect a rate of return of 15% on the stock. b. Find the price and P/E ratio of the firm if the plowback ratio is reduced to 0.40. (Do not round intermediate calculations. Round your answers to 2 decimal places.)

Answer 1

Answer:

Price 61.71 dollars

P/E 14.29 times

Explanation:

grow ratio if powback ratio is 0.40

return of 20% from which invest 40%  0.2 x 0.4 = 0.08

current earnings 3 dollars

next year earnings: 3 x 1.08 = 4.32

Now we can determinate the price using gordon model:

$\frac{divends}{return-growth} = Intrinsic \: Value$

4.32 / (0.15 - 0.08) = 61.71 dollars

price to earning ratio:

61.71 / 4.34 = 14.29