Ratios are mostly calculated using data drawn from the financial statements of a
ID: 2813168 • Letter: R
Question
Ratios are mostly calculated using data drawn from 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 Green Caterpillar Garden Supplies Inc.: Green Caterpillar Garden Supplies Inc. just reported earnings after tax (also called net income) of $95,000,000, and a current stock price of $20.25 per share. The company is forecasting an increase of 25% for its after-tax income next year, but it also expects it will have to issue 2,800,000 new shares of stock (raising its shares outstanding from 5,500,000 to 8,300,000) If Green Caterpillar's forecast turns out to be correct and its price-to-earnings (P/E) ratio does not change, what doe the company's management expect its stock price to be one year from now? (Round any P/E ratio calculation to four decimal places). O $16.78 per share $20.25 per share O $12.59 per share O $20.98 per share One year later, Green Caterpillar's shares are trading at $54.56 per share, and the company reports the value of its total common equity as $27,854,800. Given this information, Green Caterpillar's market-to-book (M/B) ratio is Can a company's shares exhibit a negative P/E ratio? O No Which of the following statements is true about market value ratios? O High P/E ratios could mean that the company has a great deal of uncertainty in its future earnings. Low P/E ratios could mean that the company has a great deal of uncertainty in its future earnings.Explanation / Answer
Answer a.
Current Net Income = $95,000,000
Current Stock Price = $20.25
Current Number of shares outstanding = 5,500,000
Current EPS = Current Net Income / Current Number of shares outstanding
Current EPS = $95,000,000 / 5,500,000
Current EPS = $17.273
Current P/E Ratio = Current Stock Price / Current EPS
Current P/E Ratio = $20.25 / $17.273
Current P/E Ratio = 1.17
Expected Net Income = Current Net Income * 125%
Expected Net Income = $95,000,000 * 125%
Expected Net Income = $118,750,000
Expected Number of shares outstanding = 8,300,000
Expected P/E Ratio = 1.17
Expected EPS = Expected Net Income / Expected Number of shares outstanding
Expected EPS = $118,750,000 / 8,300,000
Expected EPS = $14.307
Expected P/E Ratio = Expected Stock Price / Expected EPS
1.17 = Expected Stock Price / $14.31
Expected Stock Price = $16.78 per share
Answer b.
Stock Price = $54.56
Total Common Equity = $27,854,800
Number of shares outstanding = 8,300,000
Book Value per share = Total Common Equity / Number of shares outstanding
Book Value per share = $27,854,800 / 8,300,000
Book Value per share = $3.356
Market-to-Book Ratio = Market Value per share / Book Value per share
Market-to-Book Ratio = $54.56 / $3.356
Market-to-Book Ratio = 16.26
Answer c.
Yes, a company can exhibit a negative P/E Ratio if EPS is negative.
Answer d.
Low P/E ratios could mean that the company has a great deal of uncertainty in its future earnings.
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