Question

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 $54.00 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 3,300,000). If Green Caterpillar's forecast turns out to be correct and its pricelearnings (P/E) ratio does not change, what does the company's its stock price to be one year from now? (Round any P/E ratio calculation to four decimal places.) 325.17 per share $34.00 per share $21.13 per share $35.21 per share One year later, Green Caterpillar's shares are trading at $48.36 per share, and the company reports the value of its total common equity as $46,752,200. Given this information, Green Caterpillar's market to book (H/B) ratio is e soco

Answer 1

Given,

Net income after tax = $95,000,000

No.of outstanding shares at the end of current year = 5,500,000

Computation of share price after one year

EPS = earings available to shareholders/ no.of shares outstanding = $95,000,000÷5,500,000 = $17.27

PE ratio = Market price / EPS = $34/$17.27 = 1.9687

Expexted increase in earnings in next year = $95,000,000 ×25% = $23,750,000.

Shares raised in next year = 2,800,000

EPS = earings available to shareholders/ no.of shares outstanding = $(95,000,000+23750000)/8,300,000= $14.3072

As specified in the question PE ratio does not change

Therefore share price after one year will be $14.3072× 1.9687 = $28.1666.

Computation of market to book value ratio

market value of share after one year = $48.36

Book value of common equity = $46,762,200

Book value of per share = $46,762,200/8,300,000 = $5.634

Market value to book value ratio = $48.36/$5.634 = 8.5836

Question 3

Yes it is possible for a company to exibit negative EPS and thus negative PE ratio.when the company is suffering from huge losses may be cash losses or provsions in enormous amounts earnings become negative paving way to negative EPS.

Since PE ratio is Market price ÷ EPS. PE ratio can also be negative

Question 4

Low PE ratio indicates stocks are undervalued. It also indicates that investors are not confident with earnings of the company in future. Thus low PE ratio states great deal of uncertainity in its future earnings.