Question

Blue Hamster Manufacturing Inc. just reported earnings after tax (also called net income) of $8,000,000 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 1,500,000 new shares of stock (raising its shares outstanding from 5,500,000 to 7,000,000).
If Blue Hamster'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).
a. $21.34 per share
b. $25.75 per share
c. $16.01 per share
d. $26.68 per share
One year later, Blue Hamster's shares are trading at $47.12 per share, and the company reports the value of its total common equity as $35, 424, 400. Given this information, Blue Hamster's market-to-book (M/B) ratio is _____.
Is it possible for a company to exhibit a negative EPS and thus a negative P/E ratio?
a. No
b. Yes
Which of the following statements is true about market value ratios? a. Companies with high research and development (R&D) expenses tend to have low P/E ratios.
b. Companies with high research and development (R&D) expenses tend to have high P/E ratios.

Answer 1

Explanation:

Current Year Price earning ratio = Net Income ÷ Number of shares

= ($17.50 × 5,500,000) ÷ $8,000,000

= 96,250,000  ÷ $8,000,000

= 12.03

Next year earnings = $8,000,000 × (1 + 25%)

= $10,000,000

Share price next year = ( $10,000,000 × 12.03) ÷ 7,000,000

= 120,300,000 ÷ 7,000,000

= 17.1857 per share

The correct answer is 17.1857 per share. Therefore, the option is not available.

Market to book ratio = market value ÷ book value

= (7,000,000 × $47.12) ÷ $35,424,400

= $329,840,000 ÷ $35,424,400

= 9.31

Negative PE ratio is likely due to the company's Negative Earnings.  Therefore yes it is possible.

b. Companies with high research and development (R&D) expenses tend to have high P/E ratios.