Question

Lake Inc. and River Inc. reported net incomes of $205,000 and $164,000, respectively, for the most recent fiscal year Both companies had 41,000 shares of common stock issued and outstanding. The market price per share of Lake's stock was $56, while River's sold for $60 per share Required a. Determine the P/E ratio for each company. b. Based on the P/E ratios computed in Requirement a, which company do investors believe has the greater potential for growth in income? Complete this question by entering your answers in the tabs below. Required A Required B Determine the P/E ratio for each company. (Do not round intermediate calculations. Round your answers to the near number) Company P/E Ratio Lake, Inc. Rover inc

Answer 1

Solution:

Required A:

Company	P/E Ratio
Lake Inc	11.2
River Inc.	15

Calculation of P/E RATIO
Particulars	Lake Inc	River Inc.
Total Earnings (A)	$   205,000	$     164,000
Total Shares (B)	$      41,000	$       41,000
EPS (C=A/B)	5	4
Market Price (D)	56	60
P/E Ratio (D/C)	11.2	15

Note:

1) P/E Ratio is calculated by dividing the Market Price Per Share by Earnings Per Share

Required B:

Investor believe River Inc. has the higher potential for growth in income.

Reason:

The price to earnings indicates the expected price of a share based on its earnings. As earnings rises , market value of the share rises and vice versa. Companies with High P/E Ratio indicates positive growth in the future performance with compared with Low P/E Ratio.

Here in this question,River Inc. has High P/E Ratio when compared with Lake Inc.