Ramsay Corp. currently has an EPS of $2.60, and the benchmark PE for the company
ID: 2724494 • Letter: R
Question
Ramsay Corp. currently has an EPS of $2.60, and the benchmark PE for the company is 25. Earnings are expected to grow at 7 percent per year.
What is your estimate of the current stock price? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
What is the target stock price in one year? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
Assuming the company pays no dividends, what is the implied return on the company’s stock over the next year? (Do not round intermediate calculations and enter your answer as a percent rounded to the nearest whole number, e.g., 32.)
Ramsay Corp. currently has an EPS of $2.60, and the benchmark PE for the company is 25. Earnings are expected to grow at 7 percent per year.
Explanation / Answer
Answer:a Using the equation to calculate the price of a share of stock with the PE ratio:
P = Benchmark PE ratio × EPS
So, with a PE ratio of 25, we find:
P = 25($2.60)
P = $65.00
Answer:b Earnings next year = $2.60 x (1+0.07) = $2.78
25 = P / $2.78
25 x $2.78 = P
$69.55 = P
Answer:c To find the implied return over the next year, we calculate the return as:
R = (P1 P0) / P0
R = ($69.55 65.00) / $65.00
R = .07, or 7%
Notice that the return is the same as the growth rate in earnings. Assuming a stock pays no dividends and the PE ratio is constant, this will always be true when using price ratios to evaluate the price of a share of stock.
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