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FinanceFundamentals of Financial Management (MindTap Course List)14th Edition

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Chapter 4, Problem 21P
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Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977

Solutions

Chapter
Section
Problem 1Q
Problem 2Q
Problem 3Q
Problem 4Q
Problem 5Q
Problem 6Q
Problem 7Q
Problem 8Q
Problem 9Q
Problem 10Q
Problem 11Q
Problem 12Q
Problem 1P
Problem 2P
Problem 3P
Problem 4P
Problem 5P
Problem 6P
Problem 7P
Problem 8P
Problem 9P
Problem 10P
Problem 11P
Problem 12P
Problem 13P
Problem 14P
Problem 15P
Problem 16P
Problem 17P
Problem 18P
Problem 19P
Problem 20P
Problem 21P
Problem 22P
Problem 23P
Problem 24P
Problem 25SP
Problem 26IC
Problem 1TCL
Problem 2TCL
Problem 3TCL
Problem 4TCL
Problem 5TCL
Problem 6TCL
Problem 7TCL
Problem 8TCL
BuyFindarrow_forward

Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977
Textbook Problem

P/E AND STOCK PRICE Fontaine Inc. recently reported net income of $2 million. It has 500,000 shares of common stock, which currently trades at $40 a share. Fontaine continues to expand and anticipates that 1 year from now, its net income will be $3.25 million. Over the next year, it also anticipates issuing an additional 150,000 shares of stock so that 1 year from now it will have 650,000 shares of common stock. Assuming Fontaine’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. The formula to calculate earnings per share is:

Earnings Per Share=Profit After TaxTotal Outstanding Shares

Price Earnings Ratio (P/E Ratio): The ratio 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 investor in that particular share. The formula of price earnings ratio is:

P/E Ratio=Market Price Per ShareEarnings Per Share

Explanation

Solution:

Given,

Price earnings ratio of current level is 10 times.

New EPS of year 1 is 5 per share.

The formula of price earnings ratio is,

P/E Ratio=Market Price Per ShareEarnings Per Share

Substitute 10 times for P/E ratio and $5 for earnings per share.

10times=Market Price Per Share$5Market Price Per Share=$50 per share

Working notes:

Compute current EPS and P/E ratio.

Profit after tax is $2,000,000.

Number of outstanding shares are 500,000.

The formula to calculate EPS is,

Earnings Per Share=Profit After TaxTotal Outstanding Shares

Substitute $2,000,000 for profit after tax and 500,000 for total outstanding share.

Earnings Per Share=$2,000,000500,000shares=$4 per share

Compute current P/E ratio of the share

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Ch-4 P-1QCh-4 P-2QCh-4 P-3QCh-4 P-4QCh-4 P-5QCh-4 P-6QCh-4 P-7QCh-4 P-8QCh-4 P-9QCh-4 P-10Q
Ch-4 P-11QCh-4 P-12QCh-4 P-1PCh-4 P-2PCh-4 P-3PCh-4 P-4PCh-4 P-5PCh-4 P-6PCh-4 P-7PCh-4 P-8PCh-4 P-9PCh-4 P-10PCh-4 P-11PCh-4 P-12PCh-4 P-13PCh-4 P-14PCh-4 P-15PCh-4 P-16PCh-4 P-17PCh-4 P-18PCh-4 P-19PCh-4 P-20PCh-4 P-21PCh-4 P-22PCh-4 P-23PCh-4 P-24PCh-4 P-25SPCh-4 P-26ICCh-4 P-1TCLCh-4 P-2TCLCh-4 P-3TCLCh-4 P-4TCLCh-4 P-5TCLCh-4 P-6TCLCh-4 P-7TCLCh-4 P-8TCL

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