Ratios are mostly calculated based on the financial statements of a firm. Howeve
ID: 2811688 • Letter: R
Question
Ratios are mostly calculated based on the financial statements of a firm. However, another group of ratios, called market-based ratios, relate to a firm's observable market value, stock prices, and book values, integrating information from both the market and the firm's financial statements. Consider the case of Niagular Corp.: Niagular Corp. just reported a net income of $9,250,000, and its current share price is $12.00 per share. Niagular Corp. is forecasting an increase of 25% for its net income next year, but it also expects it will have to issue 3,000,000 new shares of stock (raising its shares outstanding from 5,500,000 to 8,500,000) If Niagular Corp.'s forecast turns out to be correct and its price-to-earnings (P/E) ratio does not change, what does Niagular Corp. expect its share price to be one year from now? O $9.71 O $12.00 O $7.28 $12.14 One year later, Niagular Corp.'s share is trading at $13.98, and the company reports its common equity value as 16,507,000. What is Niagular Corp.'s market-to-book (M/B) ratio? Is it possible for a company to have a negative EPS and thus a negative P/E ratio? Which of the following statements is true about market value ratios? O Low P/E ratios could mean that the company has a great deal of uncertainty in its future earnings O High P/E ratios could mean that the company has a great deal of uncertainty in its future earnings.Explanation / Answer
Answer a.
Current Year:
Net Income = $9,250,000
Current Share Price = $12.00
Number of shares outstanding = 5,500,000
Earnings per share = Net Income / Number of shares outstanding
Earnings per share = $9,250,000 / 5,500,000
Earnings per share = $1.6818
P/E Ratio = Current Share Price / Earnings per share
P/E Ratio = $12.00 / $1.6818
P/E Ratio = 7.135
Next Year:
Net Income = Current Year’s Net Income + 25% * Current Year’s Net Income
Net Income = $9,250,000 + 25% * $9,250,000
Net Income = $11,562,500
Number of shares outstanding = 8,500,000
Earnings per share = Net Income / Number of shares outstanding
Earnings per share = $11,562,500 / 8,500,000
Earnings per share = $1.3603
P/E Ratio = 7.135
Current Share Price / Earnings per share = 7.135
Current Share Price / $1.3603 = 7.135
Current Share Price = $9.71
Answer b.
Number of shares outstanding = 8,500,000
Current Share Price = $13.98
Book Value of Equity = $16,507,000
Book Value per share = Book Value of Equity / Number of shares outstanding
Book Value per share = $16,507,000 / 8,500,000
Book Value per share = $1.942
Market-to-book Ratio = Current Share Price / Book Value per share
Market-to-book Ratio = $13.98 / $1.942
Market-to-book Ratio = 7.20
Answer c.
Low P/E ratios could mean that the company has a great deal of uncertainty in its future earnings.
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