Cute Camel Woodcraft Company Just reported earnings after tax (also called net income) of $9, 750,000, and a current stock price of $36.75 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, 900,000 new shares of stock (raising its shares outstanding from 5, 500,000 to 8, 400,000). If Cute Camel'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.)
Answer:
The scenario says that
Previous P/E ratio = New P/E ratio after issuance of ordinary shares and increase in earnings after tax
So we have to only find previous data before any changes to find previous P/E ratio which is equal to new P/E ratio. This means it could be used to find new share price which has changed due to increase earnings and ordinary shares.
Previous P/E ratio = ($36.75 per share * 5,500,000 shares)/$9,750,000
= $20.7308 per share
New P/E Ratio = Market Value of total ordinary shares / Total Earnings
Previous (P/E) = Share price * Total ordinary shares / prev. ear. * 125%
This implies
Share price = Previous (P/E) * Previous earnings * 125% / Total ordinary shares
Share price = $20.7308 / share * $9,750,000 *125% / $8,400,000
Share price = $30.0781 per share.
