Question

7. Market value ratios

Ratios are mostly calculated using data drawn from the financial statements of a firm. However, another group of ratios, called market-based 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 Cold Goose Metal Works Inc.:

Cold Goose Metal Works Inc. just reported earnings after tax (also called net income) of $95,000,000, and a current stock price of $14.75 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 2,800,000 new shares of stock (raising its shares outstanding from 5,500,000 to 8,300,000).

If Cold Goose’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? (Note: Round intermediate calculations to four decimal places. Round the expected stock price to two decimal places.)

$12.22 per share

$15 per share

$9.17 per share

$15.28 per share

One year later, Cold Goose’s shares are trading at $47.12 per share, and the company reports the value of its total common equity as $20,285,200. Given this information, Cold Goose’s market-to-book (M/B) ratio is   . (Note: Do not round intermediate calculations.)

Is it possible for a company to exhibit a negative EPS and thus a negative P/E ratio?

No

Yes

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

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

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

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Answer 1

Ans: - As per this question the Cold Goose Inc. reported Net income is $95000000. The company forecast it's after-tax income to be increased by 25% next year. The number of shares this year is 5500000.

Earning per share of the company will be 95000000/5500000 = 17.2727.

Now the P/E ratio of the company will be Company share price/ Earning per share = 14.75/17.2727 = 0.8539.

   Now the Income of the company next year will be 95000000* (1+0.25) = $118750000 will the new income.

Now New Earning per share of the company will be 1187500000/8300000 = 14.3072.

Now the company's share price next year will be given by P/E ratio* Earning per share = 0.8539*14.3072 = 12.22 per share.

Ans: In this part, we have to find the Market to Book value of the company ratio.

The total market value of the company will be given by (Share price* No of shares)

47.12*8300000 = 3910696000.

Now the M/B value ratio will be Total market value/ Book value = 3910696000/20285200 = 19.27.

Ans: Yes it may be possible for a company to exhibit a negative EPS thus have a negative P/E ratio when the earning of the company is negative. Hence True i.e option b is the right answer.

Ans: For market ratio, option b is true

Low P/E ratio could mean that the company could have a greater deal of uncertainty in future earnings. This is because the market has allocated a low price because the future earning seems to be volatile of the company due to the low P/E ratio. Therefore the investor will buy less such types of stocks and hence the price will fall automatically.