Castles in the Sand generates a rate of return of 20% on its investments and maintains a plow back 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 plow back ratio is reduced to .20?
c. Show that if plow back equals zero, the earnings-price ratio, E/P, falls to the expected rate of return on the stock.
Rate of return.......... 20.00%
Plow back ratio... ..... 0.30
Earnings this year ......$4.00
Expected rate of return....12.00%
Plow back ratio (b) ...... 0.20
Plow back ratio (c) ......0.00