Shabba Inc. is a growing firm and has $1,000,000 in earnings and excess cash of $500,000. The company has had a good year and is trying to decide whether retain and reinvest the cash or pay it out to its shareholders in the form of dividends.

The company has 300,000 shares outstanding and a P/E ratio of 16.

If the funds are retained and reinvested at 15 percent, the companys P/E ratio would increase by 25 percent.

On the other hand, If the funds are paid out in the form of dividends, it is expected that that the P/E ratio will increase by 10 percent.

Required: Advise the company what action they should take and provide calculations to support your recommendations.