Question

If you know that P / E ratio (share price multiplier) of a company = 20 times, and the price of the common stock in the market = 20 $ and the number of common stocks = 500000 share with a par value of 2 $ and the number of preferred stocks 500000 with a par value of one $ paying dividends 10% yearly, find the net Profit of the company?

Answer 1

SOLUTION:

We know that:

P/E Ratio = Market value per share / Earnings per share

20 = $20 / Earnings per share

Earnings per share = $20/20 = $1

Total earnings of all common stock shareholders = Number of common stocks * earnings per share

= 5,00,000 * 1 = $5,00,000

Amount paid as dividends to preferred stocks shareholders

= Number of preferred stock shares * par value of each share * Dividend Rate

= 5,00,000 * 1 * 10% = $50,000

The total amount paid as dividend to common stock shareholders and preferred stocks shareholders

= Total earnings of all common stock shareholders + Amount paid as dividends to preferred stocks shareholders

= $5,00,000 + $50,000 = $5,50,000

We know that Net profit is the amount available for distribution to the common stock shareholders and preferred stocks shareholders. A business can also retain some amount in the form of retained earnings & profits from the Net profit, and distribute the rest of the amount to the shareholders. In our question no information has been provided about retained earnings, therefore it has been assumed that the entire net profit was distributed between the common stocks shareholders and preferred stocks shareholders.

Hence the total amount paid as dividend to common stock shareholders and preferred stocks shareholders is the Net Profit.

Therefore, Net Profit = $5,50,000