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Fundamentals of Financial Manageme...

9th Edition
Eugene F. Brigham + 1 other
ISBN: 9781305635937

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

9th Edition
Eugene F. Brigham + 1 other
ISBN: 9781305635937
Textbook Problem
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P/E AND STOCK PRICE Ferrell Inc. recently reported net income of $8 million. It has 540,000 shares of common stock, which currently trades at $21 a share. Ferrell continues to expand and anticipates that 1 year from now, its net income will be $13.2 million. Over the next year, it also anticipates issuing an additional 81,000 shares of stock so that 1 year from now it will have 621,000 shares of common stock. Assuming Ferrell’s price/earnings ratio remains at its current level, what will be its stock price 1 year from now?

Summary Introduction

To determine: The stock price in 1 year, if price/earnings ratio remains at its current level.

Earnings per Share (EPS):

Earnings per share, is the ratio of profit after tax and number of outstanding equity share. It is the amount earned by each equity shares of the company. Earnings per share determine the profitability of the firm in terms of equity shares.

Price Earnings Ratio (P/E Ratio):

The ratio of the earnings per share and market price of a share is called price earnings ratio. This ratio indicates that to earn one rupee, how much money an investor need to invest in that particular share.

Explanation

Given,

Price earnings ratio of current level is 1.4179 times (working note).

New EPS of year 1 is $21.25 per share.

The formula of price earnings ratio is,

P/E Ratio=Market Price Per ShareEarnings Per Share

Substitute 1.4179 times for P/E ratio and $21.25 for earnings per share.

1.4179 times=Market Price Per Share$21.25Market Price Per Share=$30.13

Working notes:

Compute current EPS and P/E ratio.

Profit after tax is $8,000,000.

Number of outstanding shares are 540,000.

The formula to calculate EPS is,

Earnings Per Share=Profit After TaxTotal Outstanding Shares

Substitute $8,000,000 for profit after tax and 540,000 for total outstanding share.

Earnings Per Share=$8,000,000540,000shares=$14.81per share

Compute current P/E ratio of the share

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