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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 P/E ratio of the firm
b. What happens to the P/E ratio if the plowback ratio is reduced to .20? Why?
c. Show that if plowback equals zero, the earnings-price ratio, E/P, falls to the expected rate of return on the stock.

 

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