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6 October, 15:35

Even Better Products has come out with a new and improved product. As a result, the firm projects an ROE of 20%, and it will maintain a plowback ratio of 0.30. Its earnings this year will be $2 per share. Investors expect a 12% rate of return on the stock. Required: (a) At what price and P/E ratio would you expect the firm to sell

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  1. 6 October, 15:47
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    The correct answer is 23.33 and 11.67.

    Explanation:

    According to the scenario, the given data are as follows:

    ROE = 20%

    Plowback ratio = 0.30

    Earning per share = $2

    Rate of return = 12%

    So, we can calculate the price and P/E ratio by using following formula:

    First we calculate the growth rate of the company.

    So, Growth rate (g) = Plowback ratio * ROE

    By putting the value we get,

    Growth rate = 0.30 * 0.20 = 6%

    Now we calculate the price,

    So, Price = Earning * (1 - Plowback ratio) : (Return rate - Growth rate)

    = $2 * (1 - 0.30) : (0.12 - 0.06)

    = 1.4 : 0.06

    = 23.33

    And P/E ratio = Price : earning per share

    = 23.33 : 2

    = 11.67
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