Question

Green Caterpillar Garden Supplies Inc. just reported earnings after tax (also called net income) of $95,000,000, and a current stock price of $17.50 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 does the company's management expect its stock price to be one year from now? (Note: Round intermediate calculations to four decimal places. Round the expected stock price to two decimal places.) $14.50 per share $18 per share $10.88 per share O $18.13 per share One year later, Green Caterpillar's shares are trading at $52.08 per share, and the company reports the value of its total common equity as $24,070,000. Given this information, Green Caterpillar's market-to-book (M/B) ratio is . (Note: Do not round intermediate calculations.) Is it possible for a company to exhibit a negative EPS and thus a negative P/E ratio? No Yes Which of the following statements is true about market value ratios? O Companies with high research and development (R&D) expenses tend to have high P/E ratios. O Companies with high research and development (R&D) expenses tend to have low P/E ratios.

Answer 1

(a)-Expected stock price one year from now

Current Year EPS = Net Income / Number of shares outstanding

= $95,000,000 / 5,500,000 Shares

= $17.2727 per share

Price-Earnings Ratio = Market Price per share / EPS

= $17.50 per share / $17.2727 per share

= 1.0132 Times

EPS for the coming year = Expected Net Income / Number of shares outstanding

= ($95,000,000 x 125%) / 8,300,000 Shares

= $118,750,000 / 8,300,000 Shares

= $14.3072 per share

Therefore, the Expected stock price one year from now

= EPS for the coming year x Price-Earning Ratio

= $14.3072 per share x 1.0132 Times

= $14.50 per share

“Hence, the Expected stock price one year from now will be $14.50”

(b)-Market-to-Book Ratio

Book Value per share = Market Value of Equity / Number of shares outstanding

= $24,070,000 / 8,300,000 Shares

= $2.90 per share

Therefore, the Market-to-Book Ratio = Market Value per share / Book Value per share

= $52.08 per share / $2.90 per share

= 17.96 Times

“Hence, the Market-to-Book Ratio will be 17.96 Times”

(c)-Can a company’s stock has a negative P/E Ratio

“YES”. The Company’s stock can also have a negative P/E Ratio.

(d)-The true statement regarding market value ratio is “Companies with high research and development (R&D) expenses tends to have high P/E ratios“