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Payout ratio/ Plowback ratio: What do you conclude about the relationship between growth opportunities and P/E ratios?

P/E Ratios. Web Cities Research projects a rate of return of 20 percent on new projects. Management plans to plow back 30 percent of all earnings into the firm. Earnings this year will be $2 per share, and investors expect a 12 percent rate of return on the stock.

a- What is the sustainable growth rate?
b- What is the stock price?
c- What is the present value of growth opportunities?
d- What is the P/E ratio?
e- What would the price and P/E ratio be if the firm paid out all earnings as dividends?
f- What do you conclude about the relationship between growth opportunities and P/E ratios?

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Solution Preview

a) Growth rate = ROE*plow back ratio = 20%*30%=6%

b) Dividends this year = Earnings*(1-Plow back ratio) = ...

Solution Summary

Calculations shown for you.

$2.19