Question

Ratios are mostly calculated using data drawn from the financial statements of a firm. However, another group of ratios, called market value 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 Cute Camel Woodcraft Company:

Cute Camel Woodcraft Company just reported earnings after tax (also called net income) of $9,000,000 and a current stock price of $20.25 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 2,500,000 new shares of stock (raising its shares outstanding from 5,500,000 to 8,000,000).

If Cute Camel’s forecast turns out to be correct and its price/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.)

$17.41 per share

$20.25 per share

$13.06 per share

$21.76 per share

One year later, Cute Camel’s shares are trading at $49.60 per share, and the company reports the value of its total common equity as $27,856,000. Given this information, Cute Camel’s market-to-book (M/B) ratio is   .

Can a company’s shares exhibit a negative P/E ratio?

Yes

No

Which of the following statements is true about market value ratios?

Low P/E ratios could mean that the company has a great deal of uncertainty in its future earnings.

High P/E ratios could mean that the company has a great deal of uncertainty in its future earnings.

Answer 1

(a)-Expected stock price one year from now

Current Year EPS = Net Income / Number of shares outstanding

= $9,000,000 / 5,500,000 Shares outstanding

= $1.64 per share

Price-Earnings Ratio = Market Price per share / EPS

= $20.25 per share / $1.64 per share

= 12.3750 Times

EPS for the coming year = Expected Net Income / Number of shares outstanding

= ($9,000,000 x 125%) / 8,000,000 Shares outstanding

= $11,250,000 / 8,000,000 Shares outstanding

= $1.41 per share

Therefore, the Expected stock price one year from now

= EPS for the coming year x Price-Earnings Ratio

= $1.41 per share x 12.3750 Times

= $17.41 per share

“Hence, the Expected stock price one year from now = $17.41 per share”

(b)-Market-to-Book Ratio

Book Value per share = Market Value of Equity / Number of shares outstanding

= $27,856,000 / 8,000,000 Shares outstanding

= $3.48 per share

Therefore, the Market-to-Book Ratio = Market Value per share / Book Value per share

= $49.60 per share / $3.48 per share

= 14.24 Times

“Hence, the Market-to-Book Ratio will be 14.24 Times “

(c)-Can a company’s stock has a negative P/E Ratio

“YES”. The Company’s stock can also have a negative P/E Ratio.

(d)-The true statement regarding market value ratio is “Low P/E ratios could mean that the company has a great deal of uncertainty in its future earnings”