Question

Even Better Products has come out with an even better 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. a. At what price and P/E ratio would you expect the firm to sell? (Do not round intermediate calculations. Round your answers to 2 decimal places.)

Answer 1

Answer:

Current Price is $23.33

P/E ratio is 11.66

Explanation:

Computing the P/E ratio by dividing the current price with the projected earnings:

P/E ratio = Current Price / Projected earnings

where

Current Price is to be computed as:

Current Price = EPS × ( 1 - Plow back ratio) / Rate of return - (ROE - Plow back ratio)

= $2 × (1 - 0.30) / 0.12 - (0.20 × 0.30)

= $2 × 0.7 / 0.12 - 0.06

= $1.4 / 0.06

= $23.33

Projected earnings is $2

Putting the values above:

= $23.33 / $2

= 11.66