Question

Market value ratios

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 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 $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 2,800,000 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/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.)

$16.78 per share

$20.25 per share

$12.59 per share

$20.98 per share

One year later, Cold Goose’s shares are trading at $52.08 per share, and the company reports the value of its total common equity as $27,854,800. Given this information, Cold Goose’s market-to-book (M/B) ratio is (1.21,23.25,37.24,15.50x ) .

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?

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. We know that the P/E Ratio is Price/Earnings of the Company. Currently the company has Net income/Earnings of $ 95,000,000 with 5,500,000 shares. The current per share price is $ 20.25. Thus to find P/E we need to find Earning per Share (EPS).

EPS is given by Net Income / No of Shares

EPS = 95,000,000 / 5,500,000

EPS = 17.2727272727

EPS = 17.2727

P/E is given by Price / Earning

= 20.25 / 17.2727

= 1.1723702722

= 1.1724

Now the No of Shares have Increased to 8,300,000

The Net Income is increased 25% from 95,000,000 Thus 1.25 * 95,000,00 = 11,87,50,000

EPS is given by Net Income / No of Shares

= 118750000/8300000

= 14.3072289157

= 14.3072

Now we know P/E is going to remain same

P/E = 1.1724

P/E is given by Price / Earnings

We don'e have the price so keeping price as variable

Price = (P/E) * EPS

= 1.1724 * 14.3072

= 16.773

= 16.78

b. Market to Book Ratio is given by Market Price to Book Value of shares

Here we have 8,300,000 shares

Per Share Price is $ 52.08

Market Value is No of Shares * Per Share Price

= 8,300,000 * 52.08

= $ 432,264,000

Book Value is $ 27,854,800

Market to Book Value is 432,264,000 / 27,854,800

= 15.51847

= 15.52

c. Yes it is possible that a company have a negative earning thus the eps is negative and with a positive share price the P/E ratio will be negative

d. Low P/E ratio is due to lower Price of share with respect to its income and it could happen when the future earnings may not be steady with respect to current earnigs thus this statement is true.

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