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26 February, 22:20

Castles in the Sand generates a rate of return of 12% on its investments and maintains a plowback ratio of. 40. Its earnings this year will be $3 per share. Investors expect a 10% 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 of the plowback ratio is reduced to. 30. (Do not round intermediate calculations. Round your answers to 2 decimal places.) Price $ P/E ratio

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  1. 26 February, 22:30
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    (a) $34.61; 11.54

    (b) $32.81; 10.94

    Explanation:

    (a) Stock Price = D : (Ke - G)

    Where,

    D is dividend next year,

    Ke is required rate of return on equity

    G is growth rate

    Growth rate = ROE * plow-back ratio

    = 0.12 * 0.40

    = 0.048 or 4.8%

    Dividend = Current EPS * (1 - plow back ratio)

    = $3 * 0.6

    = $1.8

    Stock Price:

    = $1.8 : (0.10 - 0.048)

    = $34.61

    P/E Ratio = Stock Price : EPS

    = $34.61 : $3

    = 11.54

    (b) New growth rate = 0.12 * 0.30

    = 0.036 or 3.6%

    Dividend = Current EPS * (1 - plow back ratio)

    = $3 * 0.7

    = $2.1

    Stock Price = $2.1 : (0.10 - 0.036)

    = $32.81

    P/E Ratio = Stock Price : EPS

    = $32.81 : $3

    = 10.94
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