Question

For the year ended 31 December 2016 a company earned a profit after interest and tax of
£480,000. The company’s share price is £12 per share. The following are extracts from the
company’s Statement of financial position at 31 December 2016:
Ordinary share capital (50p shares) £200,000
Retained earnings £380,000
Revaluation reserve £80,000
Long-term 10% Bank loan £48,000
The company’s price earnings (PE) number and return on equity for the period were:

Answer 1

Ordinary Share Capital Value = £200,000

Book Value of Each Share = 50 pence or 0.5 £

Number of Ordinary Shares = Ordinary Share Capital Value / Book Value of Each Share = 200000 / 0.5 = 400000

NOTE: The number of ordinary shares is calculated using the Book Value per share instead of market value as the total ordinary share capital is recorded at its book value or issue value.

Net Income = £ 480000

Earnings Per Share = Net Income / Number of Ordinary Shares =480000 / 400000 = £ 1.2

Market Price Per Share = £12

Therefore, PE Ratio = Market Price Per Share / Earnings Per Share = 12/ 1.2 = 10

Retained Earnings = £380,000

Revaluation Reserves = £80,000

Ordinary Share Capital Value = £200,000

Total Assets = Retained Earnings + Revaluation Reserves + Ordinary Share Capital Value = 380000 + 80000 + 200000 = £ 660000

Total Liabilities = £48000

NOTE: Long Term Interest bearing debt is assumed to be the company's only liability on account of lack of any further information.

Therefore, Shareholder's Equity = Total Assets - Total Liabilities = 660000 - 48000 = £ 612000

Therefore Return on Equity (ROE) = [Net Income / Shareholder's Equity] x 100 = 78.43 %