1. Firm D and Firm E have the same performance characteristics. They both have a P/E of...

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1. Firm D and Firm E have the same performance characteristics. They both have a P/E of 20× and they also have the same cost of capital, return on equity, etc. The only difference is that Firm E’s economic book value is $25 billion and Firm D’s economic book value is $25 million.

Explain why, in the language of the FFM, Firm E’s P/E is more likely to decline than Firm D’s.

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