# Question

Castles in the Sand generates a rate of return of 20% on its investments and maintains a plowback ratio of .30. Its earnings this year will be $4 per share. Investors expect a 12% rate of return on the stock.

a. Find the price and P/E ratio of the firm.

b. What happens to the P/E ratio if the plowback ratio is reduced to .20?

c. Show that if plowback equals zero, the earnings-price ratio, E/P, falls to the expected rate of return on the stock.

Rate of return.......... 20.00%

Plowback ratio... ..... 0.30

Earnings this year ...... $4.00

Expected rate of return.... 12.00%

Plowback ratio (b) ...... 0.20

Plowback ratio (c) ...... 0.00

a. Find the price and P/E ratio of the firm.

b. What happens to the P/E ratio if the plowback ratio is reduced to .20?

c. Show that if plowback equals zero, the earnings-price ratio, E/P, falls to the expected rate of return on the stock.

Rate of return.......... 20.00%

Plowback ratio... ..... 0.30

Earnings this year ...... $4.00

Expected rate of return.... 12.00%

Plowback ratio (b) ...... 0.20

Plowback ratio (c) ...... 0.00

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