Question

7. Market value ratios Aa Aa E 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 $8,500,000, and a current stock price of $25.75 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 2,000,000 new shares of stock (raising its shares outstanding from 5,500,000 to 7,500,000). 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? (Round any P/E ratio calculation to four decimal places). $23.59 per share $25.75 per share $17.69 per share $29.49 per share One year later, Green Caterpillar's shares are trading at $50.84 per share, and the company reports the value of its total common equity as $35,385,000. 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 Yes O No Which of the following statements is true about market value ratios? Companies with high research and development (R&D) expenses, and thus strong growth potential, tend to have high P/E ratios. Companies with high research and development (R&D) expenses, and thus strong growth potential, tend to have low P/E ratios.

Answer 1

Soln Year 2 (a) (6) 4,500,000 Year! 5500,000 $8,500,000 Shares outstanding Net Income. $ 10,625,000 8500,000 X 1.25] $ 1.4167 (c) Earnings Per Share $1.5455 (d) Market Price per Share $25.75 $23.60 (C) Ple Ratio - 17 16.6613 times 16.6613 times [Since PlE ratio is same? Therefore market Price per share for Year 2 = Earnings per share x P/E ratio. = 1.4167 X 16.6613 = $23.60 / share or $23.59/ share (as given in optiona)

Market to Book Ratio = Market Total Capitalisation Book Value. = $50.84 x 7500000 $35,385,000 - Portation 10.78 times A negative P/E ratio means the company has negative earnings or is losing money. Even the most established companies experience down periods, which may be due to environmental factors that are out of the company's control. ( A negative ple may not be reported. Instead, the EPS might be reported as "not applicable" for quarters in which a company exported a loss. Therefore, a company's shares can eachibit a negative PlE ratio.

Do companies with high research and development expenses, and thus, strong growth potential, tend to have high Ple ration! Generally Yes, higher Ple oratio means higher the expectations on a company to deliver earnings growth From buyer's point of view, you want the price to be low, earnings to be high. Lower PlE ratio becomes more desirable in this case. However, people buy stocks with high Ple oratios too and the reason is their expectations. They are willing to buy into a high ple because they believe earnings will continue to grow. & company with huge R&D will have high Ple at its earnings will be less but the investors will be willing to buy it because of its growth potential. V