1. Advise Creative Corner Inc. what action they should take (with calcualtions to justify your advice). (8 marks)
2. Would your advice change if P/E ratio increased by 20% in both situations?

Creative Corner Inc. has $700,000 in earnings and excess cash of $500,000 and is trying to decide whether to pay out these funds to its shareholders in the form of dividends or reinvest it in the company. The company has 350,000 shares outstanding and a P/E ratio of 14 . If the funds are paid out in the form of dividends, it is projected that the P/E ratio will increase by 20% as the majority of its shareholders are on a fixed income and prefer to receive dividend payments in order to supplement their income. As an alternative the funds could be retained and reinvested at 15% in which case the P/E ratio would remain unchanged