Question

Consider Pacific Energy Company and U.S. Bluechips, Inc., both of which reported earnings of $959,000. Without new projects, both firms will continue to generate earnings of $959,000 in perpetuity. Assume that all earnings are paid as dividends and that both firms require a return of 12 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.)

  

PE ratio

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b.	Pacific Energy Company has a new project that will generate additional earnings of $109,000 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.)

  

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c.	U.S. Bluechips has a new project that will increase earnings by $209,000 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.)

  

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Answer 1

Answer a
Calculate the PE ratio for each company
PE ratio i.e. Price Earning Ratio = Current Market value of Company / Company earnings available to stockholders
Current Market value of Pacific Energy Company and U.S. Bluechips, Inc. = Yearly earnings / Required rate of return
Current Market value of Pacific Energy Company and U.S. Bluechips, Inc. = $959000 / 12% = $79,91,667.67
PE ratio for each company = $79,91,667.67 / $9,59,000 = 8.33 times
Answer b
Current Market value of Pacific Energy Company = [$959000 + $109000] / 12% = $89,00,000
New PE ratio for Pacific Energy company = $89,00,000 / $10,68,000 = 8.33 times
Answer c
Current Market value of U.S. Bluechips = [$959000 + $209000] / 12% = $97,33,333.33
New PE ratio for U.S.Bluechips = $97,33,333.33 / $11,68,000 = 8.33 times