answer the multiple choice quesn Day the interest on its debt Canada Transportat
ID: 2653570 • Letter: A
Question
answer the multiple choice quesn Day the interest on its debt Canada Transportation Limited currently trades for STo A conclusion Toronto Logistics trades for $54 with a P/E ratio of 38.6. A co drawn from these numbers, is that the market believes for $70 with a P/E ratio of 16.4. e market belier 86. A conclusion that could be A) Canada Transportation is less risky than Toronto Logistics B) Toronto Logistics earnings will overtake Canada Transportat share price C) Canada Transportation's assets are D) Toronto Logistics is no longer a good investment E) Toronto Logistics has higher earnings than Canada Transportation tation hare undervalued relative to its sExplanation / Answer
Before answering , lets first understand what P/E ratio is.
P/E ratio is price per earning. It is the dollar amount an investor is willing to pay to earn $1.
P/E= (1-b)/(r-g) where
1-b : dividend payout ratio
r: required rate of return (higher required rate of return for riskier company)
g: growth rate of campany
High P/E ratio would mean low r and high g. Canada Transportation has lower P/E than Toronto Logistics which means it may be riskier (higher r) than later.
Canada Transportation has lower P/E ratio which not necessarily mean it is undervalued. It may be the case that company is screwed or market believes that company is headed for trouble in the near future.
Toronto Logistics has higher P/E ratio, means investors are willing to pay (are paying) a higher price for the stock compared to its earnings because they believe the company has good growth prospects (higher g in the above equation).
EPS for Toronto Logistics = 1.39
EPS for Canada Transportation = 4.26
We can not conclude about total earnings of these two companies (that would need no. of shares outstanding) but EPS of Toronto Logistics is less than Canada Transportation.
Finally, Toronto logistics earnings would increase in future (and lower its P/E ratio to industry average).
Hence correct answer is (B).
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