Question

Consider Pacific Energy Company and Atlantic Energy, Inc., both of which reported earnings of $961,000. Without new projects, both firms will continue to generate earnings of $961,000 in perpetuity. Assume that all earnings are paid as dividends and that both firms require a return of 14 percent. a. What is the current PE ratio for each company? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) b. Pacific Energy Company has a new project that will generate additional earnings of $111,000 each year in perpetuity. Calculate the new PE ratio of the company. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) c. Atlantic Energy has a new project that will increase earnings by $211,000 in perpetuity. Calculate the new PE ratio of the firm. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Answer 1

Answer:

A. 7.14

B. 7.96

C.8.71

Explanation:

A. Calculation for the the current PE ratio for each company

First step is to find the market value of the stock using this formula

Market value of stock=Earnings/Return percentage

Let plug in the formula

Market value of stock =$961,000/0.14

Market value of stock =6,864,285

Last step is to find the current PE ratio for each company using this formula

Current PE ratio=Market value of stock/Earnings

Let plug in the formula

Current PE ratio=6,864,285/$961,000

Current PE ratio=7.14

Therefore the Current PE ratio is 7.14

B. Calculation for the new PE ratio of the company

First step is to find the market value of the stock using this formula

Market value of stock =(Earnings+Additional earnings) /Return percentage

Let plug in the formula

Market value of stock =($961,000+$111,000) /0.14

Market value of stock=$1,072,000/0.14

Market value of stock=7,657,142

Last step is to find the new PE ratio of the company using this formula

New PE ratio=Market value of stock/Earnings

Let plug in the formula

New PE ratio=7,657,142/$961,000

New PE ratio=7.96

Therefore the New PE ratio is 7.96

C.Calculation for the new PE ratio of the firm

First step is to find the market value of the stock using this formula

Market value of stock =(Earnings+Increase in earnings) /Return percentage

Let plug in the formula

Market value of stock =($961,000+$211,000) /0.14

Market value of stock=$1,172,000/0.14

Market value of stock=8,371,428

Last step is to find the new PE ratio of the company using this formula

New PE ratio=Market value of stock/Earnings

Let plug in the formula

New PE ratio=8,371,428/$961,000

New PE ratio=8.71

Therefore the New PE ratio is 8.71